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Saving for College: Addressing a Significant Financial Challenge (Third of a Three Part Series)

Disclaimer: This article contains information that was factual and accurate as of the original published date listed on the article. Investors may find some or all of the content of this article beneficial but should be aware that some or all of the information may no longer be accurate. The information and/or data in this article should be verified prior to relying on it when making investment decisions. If you have any questions regarding the information contained in this article please call IFA at 888-643-3133.

Tree in hands

College Saving
Part One
 Part TwoPart ThreeCollege Saving Analyzer

In the first part of this series, we gave an overview of 529 plans and the due diligence that investors should perform before choosing one of them, and in the second part, we looked at the West Virginia Smart529Select plan with its different age-based portfolios. For this part, we will provide an overview of other types of accounts that may be used for college savings along with a description of IFA's Glide Path for college savings and a new "College Savings Analyzer" tool from IFA.

Besides the 529 plan, a tax-advantaged savings option is the Coverdell Education Savings Account (ESA). Like a 529 plan, ESAs allow money to grow tax deferred and proceeds to be withdrawn tax free for qualified education expenses, but ESAs have lower contribution limits. As of 2015, $2,000 is the maximum contribution per year per child. ESAs have virtually unlimited choices in the available investments, but this could easily prove to be a pitfall as well as an advantage for novice investors. ESAs allow withdrawing the money tax-free for qualified elementary and secondary school expenses while 529 plans are limited to post-secondary expenses only. Unlike a 529 plan, the permissibility of contributions to an ESA depends on the income of the donor. Lastly, money in both an ESA and a 529 plan is not considered the student's money when applying for federal financial aid as long as the owner of the account is not the student. This can work to the student's favor because parents are expected to contribute only around 6% of their assets to finance college education, as opposed to the student's 35%.1

Among the taxable savings options, one that provides a lot of flexibility is the Uniform Transfers to Minors Act (UTMA) account. As of 2015, a parent may give a child up to $14,000 per year ($28,000 if married filing jointly) before a gift tax must be paid.  Note that the "kiddie tax" may cause the parent's marginal rate to apply to any investment income from the UTMA account. Normally, a UTMA account terminates when the child reaches the age of majority, and the child can then deploy the funds as desired. From a financial aid perspective, a UTMA account could be disadvantageous because it is counted as the student's asset. Some 529 plans will accept funds transferred from a UTMA account.

Parents who are concerned about how their children will utilize funds over which they gain control may want to establish a trust so they can state exactly how the funds may be used. For parents who choose this option, IFA would recommend utilizing the services of an estate planning attorney.

Regardless of which type of account is utilized for college savings, it is very important to have a long-term plan for how the asset allocation will change over time. IFA's recommended glide path for college savings is shown below (assuming that attendence in College starts at age 18):

To help parents determine the adequacy of their current savings plus future contributions, IFA is pleased to introduce a new tool, the College Savings Analyzer. After inputting the student's current age, college attendance age, current savings plus planned future contributions, anticipated costs, and the number of years for which those costs must be funded, the analyzer will produce a report that estimates the probability that the goal will be met. The calculation is based on the Monte Carlo method of repeated random trials using returns based on long-term historical data. IFA's recommendation is to discuss the report with a qualified investment advisor who uses passive funds only. Also, the report should be re-run on at least an annual basis to ensure that the inputs are up-to-date. If you have any questions about using the analyzer, please feel free to call us at 888-643-3133, and one of our advisors will be happy to assist you.

This table provides simulated passive investor experiences for investors who are saving for college. The best way to explain this concept is to go through an example. Suppose that you have a 10-year old child that you expect to begin college at age 18. In the top row, select age 10, and you will see that the starting portfolio is now IFA Index Portfolio 50. The multi-colored rows show how the glide path decreases by five portfolio levels each year. Suppose that we wanted to see how over the last 50 years our simulated passive investors (each with a different starting month) performed over an 8-year period--we simply look at the row of data for 8 years where we see the median return, the range of returns, and the high and low returns received along with the corresponding growth of $1. This can be a useful tool to gain an understanding of both the risk and the potential return of a glide path strategy.



College Saving
Part One | Part TwoPart ThreeCollege Saving Analyzer