Tax and Financial News for November 2013

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Outrunning Rising College Costs

It is no surprise that the cost of college is rising fast – at approximately twice the rate of general inflation. As a result, many parents and would-be parents are concerned with how to handle paying for their children’s college in the future. To help you visualize just how big of a challenge saving for college might be, look at the chart below for what one year might cost:  

Examples of Current and Projected Tuition, Room, Board and Fees for One Year

  Fall 2013 – Spring 2014 Fall 2031-Spring 2032
4-year private* per year $62,496 $154,404
4-year public in-state** per year $23,744 $57,143

*Example assumes 5 percent annual inflation rate and is based on the total cost of attendance (tuition, room, board and fees) of Yale University for the academic year 2013-2014.

**Example assumes 5 percent annual inflation rate and is based on the total costs of attendance (tuition, room, board and fees) at the University of Connecticut for the academic year 2013-2014.

College costs were projected out to Fall 2031-2032 because that is 18 academic years from now – or when a recently born baby would likely start college.

Paying for such enormous college costs will likely be a multipronged approach for most families – one that includes financial aid, scholarships and strategic decisions about exactly what type of institution to attend. It is likely that a significant portion of the costs will need to be paid for by parents if they wish for their children to avoid being burdened by large amounts of student loans. Section 529 college savings plans can offer a great opportunity to help parents save. They can be set up anytime, and you can start saving before your child is even born. 

Anyone can set up a Section 529 plan, and they allow for tremendous flexibility. The person who sets up and funds the account owns it and names the beneficiary. The owner can then change the beneficiary to their child or a relative at any time without penalty. The owner can even split the account and name multiple children as beneficiaries to each account. This flexibility also makes Section 529 plans a great strategy for grandparents to use.

The value of a Section 529 plan is that it allows the earnings on your account to grow tax-deferred and the distributions are tax-free if used to pay for qualified higher education expenses. You can always liquidate the account and use the money for another purpose if you never have children. If the money is not spent on higher education, you will have to pay federal and state income taxes on the earnings in addition to a 10 percent federal penalty.

Another important factor is that each state sponsors a different plan, but you can invest in any state’s plan. Each state-sponsored plan has its own set of fees, but the majority offer either a credit or deduction against their state income tax. Remember however, that you only benefit from a credit or deduction if you pay taxes in the state that sponsors the plan.

Let’s look at a hypothetical example of how using a Section 529 plan can work. Assume a one-time investment of $10,000 for 18 years with an 8 percent annual return. Additionally, assume a federal marginal tax rate of 33 percent; a 20 percent capital gains rate; and a state income tax rate of 5 percent with the contribution deductible against state taxable income.

The $10,000 invested in a Section 529 plan would have grown to $39,960 in 18 years. If used for higher education expenses, this entire amount would be your end result. If you used it for purposes other than qualified higher education expenses, you would only have $25,579 after taxes and penalties. 

Outside of a 529 plan, a comparable investment would only start with $9,500 to account for the effect of the state tax deduction of $500 (5 percent of $10,000). This investment would grow to $37,962 and after capital gains and state income taxes would net $30,972.

Whether a Section 529 plan is right for you depends on the facts and circumstances of your situation. Call us to discuss if a Section 529 plan is right for you and how it can fit into your overall financial plan.


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