Planning for college expenses is becoming a central focus for families as the costs of higher education continue to skyrocket.Exorbitant price tags that may approach $50,000 per year are making headlines, as parents and their financial advisors look for solutions that don't delay retirement or limit a student's future. Advisors subsequently have devised a combination of savings plans, tax strategies and admissions planning to minimize the impact of pricey college expenses on families' financial plans.
From toddlers to teens
Funding strategies vary depending on the age of the child.
Planning for younger children means a combination of savings, tax and cash-flow planning. While there are many traditional types of savings plans, the vehicles that Congress, various states and financial institutions focus attention on are the 529 plans.
"We're big proponents of the 529 plans," said Mark Wilson, CFP and vice president at Tarbox Equities Inc., of Newport Beach, Calif. "And it's easier to talk with clients about the benefits, because they're hearing about them before we bring up the subject."
Planning to fund college for older children brings out the creativity in advisors. For those who have saved, the decisions run to when to move investments into those that facilitate payout, and how to choose the payouts. "There are lots of planning opportunities in the timing of withdrawals to pay for college," said Wilson. "For high school juniors, we're rebalancing to prepare for payout. For seniors, we may not plan payouts until the family has gotten their financial-aid package."
Creative tax strategies especially help families that haven't saved much money for college.
"Paying for college for some families is determining both when and how some parents are able to retire," says Deborah Fox, founder of Fox College Funding, in San Diego. Fox's firm raises awareness of proactive strategies beyond the savings plan through a nationwide network of 60 advisors.
Some of the strategies involved shifting income from parents to students. Parents can gift either the money saved for college or other appreciated assets, which shifts taxation to the child. Parents who own a business or rental property can hire the child at a reasonable wage to shift income to the child. "We've seen situations where children as young as seven have skills that can earn an honest wage," Fox said. "The key with this strategy is to be sure to pay a reasonable wage for work provided."
Higher-income families can take special advantage of the current tax code to help defray the cash outlay. The parents deduct the wages paid as expenses. The child now files his own tax return and takes a $3,200 personal exemption and a $5,000 standard deduction, and can also claim a Hope scholarship and Lifetime Learning credit. "Many times, we can zero out the income tax altogether," said Fox.
Parents can also shop for loans, as well as negotiate the price of tuition and fees.
While it is true that rates on education loans have risen, competition among lenders is fierce. "The Stafford Loan (a variable low-interest education loan) is up to 4.77 percent, and the Plus Loan for parents (a federally sponsored parent loan) is at 6.01 percent," Fox said. "But there are lenders out there that will provide discounts, some as high as 1.5 percent to 2 percent."
Ivy League haggling
Most families might be surprised that the price of college is negotiable. Merit aid packages in the amount of $5,000 or $10,000 are not unusual. Successful price negotiations result from savvy matching of students to colleges. "Families position themselves to match their child with the profile that the college is looking for," says Fox. "If a school wants a student badly, they could pay up to $25,000 in merit aid."
The increased gift tax exemption makes 529 plans more useful to parents of older children. In 2006, the gift tax exemption goes from $11,000 to $12,000. "Over two years a family could front-load the account with $60,000 each year, or $120,000," explained Janine Stubbs, senior financial planning analyst at Raymond James & Associates, in St. Petersburg, Fla. "The 529 can reduce estate taxes to zero. There's no other type of account that has this feature and the ability to avoid the gift tax."
Families using the long-term savings features of 529s can also benefit from new client services developed as the industry matures. Advisors have more resources at their fingertips to navigate the various choices of some 122 plans now available in 20 states.
"The largest issue for our advisors is taking advantage of preferred pricing on funds the client may already own," said Stubbs, who also manages 529 plans at Raymond James. "We now give our advisors the ability to access total fund assets for an investor. Buying a 529 with funds that the client already owns can save big on the cost of purchase, because of the lower price points."
Other features vary by state as well. Some give tax breaks to residents of the state, some offer creditor protection and facilitate matching contributions. Several online tools help advisors compare features, such as the one at www.savingforcollege.com.
Regulators continue to tinker with 529s. The most-watched issue is the possible extension of the sunset provision. The tax reform act of 2001 granted a huge benefit of being able to withdraw funds from the 529 tax-free, as long as the money went for educational expenses. The sunset for this provision is just five years away in 2010. "The legislation we're most eager to have happen is the extension of this tax benefit," said Tarbox's Wilson. "But if it does go back to being taxed at child's level, it's not exactly the end of the world."
Several other proposals for improving 529s keep some planning decisions in limbo.
A pending proposal by lawmakers would allow tax-free employer-matching contributions. While many advisors don't see any clear decisions coming soon, some feel that the chances are growing for improvement.
"The missing tax dollars that come with these provisions aren't anywhere as substantial as some other bills," said Wilson. "Plus, there is so much money flowing into these plans, and more money means more voters, means these tax benefits are more likely to become permanent."
