Practically Planning Ahead

News you can useEven if you’ve got a spouse at home, he or she too can be saving through an IRA called a spousal IRA. This is often forgotten, because the rules for a traditional IRA require that the IRA owners earn at least as much as they deposit each year.

You can save up to $5,000 for a stay-at-home spouse (subject to some income limits) and deduct it from your taxable income — and, if they’re over 50, even more. Still, that deduction alone could easily cut $1,400 a year off your tax bill.

In just a few months, thousands of high school students across the country will begin graduating.  You may have one of them in your home.  Let’s take a few minutes today to discuss one of the greatest budgeting tasks facing Americans families today, College.  Over the last fifty years more college educated people have entered the workforce than ever before, making higher education an even bigger ingredient to living the American Dream.

Many families today will tell you they have little or no funding set aside for their children’s education.  A good number of these people have the resources to save, however the task is so daunting they claim defeat before even starting.  A state university such as the University of Kentucky could cost upwards of $35,000 per year for tuition, room, and board in 2025 assuming a conservative 6% inflation rate.  How many of you paid less that that for your first home?  While the situation is indeed frightening, an early start and the right research will help make your children’s dreams a reality.

There are really 4 vehicles that can be used to save for higher education.  Selecting the right option for you is important, but not nearly as important as simply getting started.  Borrowing money for college can make the entire experience cost over twice as much as saving ahead of time.  Stop procrastinating and set something aside!  When this first step has been made, you are committed enough to begin exploring your options.

1)      529 College Savings Plans – Two pros and two cons.  These are terrific in that they can hold up to $250,000 at any one time, and all growth is tax-free when used for higher education.  Downside factors are that only one person at a time can be the beneficiary of the money, and it has to be used for higher education or you will pay taxes and penalties.

2)      Coverdell Education Savings Accounts – Many people refer to these as education IRAs.  While these too can be used tax free, they can be used for any qualified education expense such as private grade school or high school.  The big downside to this option is a $2,000 yearly contribution limit which is no where near enough savings to pay for school.

3)      UGMAs/UTMAs – These accounts which are for children, yet controlled by a custodian have few restrictions besides the fact that at either age 18 or 21 it becomes the child’s money.  The benefits of having this money taxed at the child’s rate (assuming less than $1,700 in unearned income) might be out weighed when Junior decides on a Corvette in lieu of Harvard or Cornell.

4)      Mom & Dad’s Money – This methodology assumes you save the money unrestricted in your name to keep full control, and simply deal with the tax implications.  It is also important to note that a parent or student’s IRA can be used for higher education expenses penalty free.

Making the proper decision here depends on three factors:

       1) How much money do you make?

       2) How much money do you have?

       3) How well do you know your children?

If you can answer at least a few of these questions you can arrive at a conclusion.  For instance a family with a young child might utilize a UTMA for the first few years.  Once they begin to know their student and their income they can decide whether to continue this approach or begin using a more restrictive savings vehicle.  A family with excellent public schools in the area and a good student will likely benefit from going the 529 Plan route since they will not need the money for grade school or high school.  Just take a few minutes to match your life with the options available to you.  The right decision could make your savings plan wildly prosperous!

We could discuss financial aid for hours (stay tuned to future newsletters), however to keep your eyes from glazing over and face from turning blue I will keep it brief.  Financial aid can play a role in your savings decision making.  Many of you will complete a FAFSA form if you have not already.  This tedious application is what Uncle Sam uses to tell you how much aid you might qualify for.  If you are someone who could potentially qualify for aid, one savings option is out of the question.  Parental assets count at 6% annually toward your expected family contribution (EFC), however student assets count at a staggering 20%.  UGMA/UTMA accounts are clearly not the way to save if you have a chance at qualifying for aid.  Short of untimely death, divorce, or overseas bank accounts (none of which I recommend) many families will not be qualifying for financial aid.

Use this opportunity not as a time to get down, but a time to get even.  Whether your children or grandchildren are 16 months or 16 years the time to save was yesterday.  Take the information you have and the budget you might have created for 2012 and start saving for higher education.  Getting the finances under control and on track now will help ensure that come Freshman year your worries are about Parent’s Weekend and what your child does without a curfew, not about making the tuition payment!

Andy is Mackey Advisors personal finance whiz kid. Andy's specialty lies in his ability to help clients craft a financial plan that works for them. He is passionate about helping people create a brighter and more prosperous future.

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