By Joyce Streithorst, CFP®, MSFS, CDFA
Saving college money for your child can sneak up on you. It can feel like just yesterday that you were watching your little one start kindergarten, and then suddenly you blinked your eyes and have a child in college or about to start.
There are few people who have saved enough money to cover 100% of college expenses. Some have set aside funds, whether in a separate account or co-mingled with other assets. Others will rely on financial aid, scholarships or loans.
Many believe that they won’t qualify for financial aid or that there is no benefit to saving in a separate account. However, even for those who have not made any prior financial preparations, there are still ways to use a 529 plan to maximize funds which can be contributed to covering the costs of education. (For related reading, see: Tax-Smart Ways to Help Your Kids/Grandkids Pay for College.)
How to Save for College As a Senior in High School
Let’s use Johnny as an example. Johnny is now a senior in high school, graduating in 2019. Johnny lives in New York and his parents have not set aside any funds for college. They are anticipating that his college costs will be $20,000 per year, after financial aid and scholarships are applied. They can afford to save $10,000 per year (approx. $192 per week) and earmark it for college.
One strategy is to save $10,000 in the NY 529 plan (www.nysaves.org) for the next six years (2018-2023). This will give Johnny $60,000 for college expenses.
New York state gives a deduction on the state tax return for contributions to 529 plans. For married couples filing joint tax returns, the maximum is $10,000 and for single tax filers it is $5,000. Johnny’s parents can deduct $10,000 each year (2018-2023) and save about $800 in New York income taxes each year. They will now have an additional $4,800 to potentially use for college expenses.
This saving should be set aside in a bank account earmarked for Johnny’s college expenses.
Appreciation within the 529 depends upon the investments selected and market returns. The additional earnings would be tax free as long as the funds are used for college.
- Johnny has $64,800 in savings for college: $60,000 + $4,800 = $64,800 in savings (assuming no appreciation).
- His college costs are $20,000 x 4 = $80,000 (ignoring the effects of inflation). His shortfall is $80,000 - $64,800 = $15,200, or $3,800 per year.
This could be funded by Johnny getting a part-time job or by applying for college loans.
How to Save While in College
Here is an example of saving while already in college. Suzie will be a senior in college, graduating in 2019. Suzie’s parents have no funds in a 529 plan and are now in a position to help pay for the last year of college. Suzie and her parents live in New York state. (For related reading, see: Are 529 Savings Plans Right for You?)
Similar to the previous example, her parents can make a contribution of $10,000 to a 529 plan in 2018 and then use those funds to pay $10,000 of Suzie’s tuition bill for her fall semester. At the beginning of January 2019, they can make a contribution of $10,000 to the 529 plan and then use those funds to pay $10,000 of Suzie’s tuition bill for her spring semester.
Timing is very important in this instance, as you must take your 529 plan distribution in the calendar year that you pay the corresponding expenses. You must also make your contribution in the calendar year for which you can then take the New York state deduction. In addition, Suzie’s school must allow for the final semester’s tuition to be paid after December 31 of the preceding year.
Assuming Suzie’s parents are in the 8% New York state tax bracket, they would save $800 on their 2018 state taxes and another $800 on their 2019 state taxes. This simple strategy can save them $1,600.
For New York City residents in the top marginal bracket, the annual tax savings when a married couple contributes $10,000 to a 529 plan is about $1,200 per year. And this is not just available for New York residents. A number of other states give a tax deduction or credit when a contribution is made to a 529 plan.
It's Never Too Late to Save for College
Setting aside funds to cover the costs of college does not need to start at birth. Tax planning strategies that can enable you to maximize your financial resources are available even in the last year of school. We recommend you speak with a tax or financial specialist to help determine appropriate strategies that make sense for you. (For more from this author, see: Financial Planning Tips for a Child’s Summer Job.)
Disclosure: Frisch Financial Group, Inc. is a registered investment adviser. Registration does not constitute an endorsement of the firm by any regulatory body, nor does it indicate that the adviser has attained a particular level of skill or ability. Information presented herein is for educational purposes only and nothing contained in this publication is intended to constitute legal, tax, or investment advice. The general information contained in this publication should not be acted upon without obtaining specific individualized legal, tax, or investment advice from an appropriately licensed professional. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk.
This article was originally published on Investopedia.