Saving for Higher Education:

There are so many options. Which one is right for you?

Everyone that has kids has thought about how they’re going to pay for college. For some, the philosophy is simple: they aren’t. They paid for their own college and they want their kids to earn it and appreciate, just like they did. For others, they want to pay for every penny of the costs associated with higher education: tuition, room, board, books, bail money, all of it. However, just like most of life, we don’t conveniently have a one-size-fits-all approach that works. Fortunately, we have a lot of possibilities, and one, or a combination of some, will likely be the option that aligns with your philosophy. Andy Dufresne, from Shawshank Redemption, lays out a few options for us in this week’s installment of Cadence Wealth Weekly.

We may never know which option fit Deacons best. But we can lay out each for you to make an educated decision, no pun intended.

The Classic Piggy Bank: “The High-Yield Edition”

Remember when saving meant stuffing your loose change into a piggy bank? Well, we’ve modernized this classic approach with a high-yield piggy bank that earns interest. OK, so it’s still just a ceramic piggy, but imagine it’s got a secret life as an investment banker, and you’re halfway there. High-yield savings accounts are a great alternative to traditional savings accounts, and can currently earn a yield 10x higher than a traditional savings option (5% vs .5%).

Pros:

• Safe
• Predictable

Cons:

• Limited growth.
• Taxes on growth each year

The “Spare Change” App: The 21st-Century Coin Jar

Why limit yourself to a physical piggy bank when you can use a spare change app? These nifty tools round up your purchases to the nearest dollar and deposit the difference into a savings account. So, every time you buy a $4.50 latte, the app automatically stashes away 50 cents. It’s like having a personal savings assistant who’s way better at math than you are—plus, it never needs a coffee break.

Pros:

• Automatic
• Safe
• Predictable

Cons:

• Limited growth.
• Taxes on growth each year

Savings Bonds: The “Old-School” Approach

U.S. Savings Bonds have been around forever and offer a conservative way to save. They’re like that reliable old friend who might not be flashy but always shows up.

Pros:

• Tax Advantages: Interest earned is tax-free when used for qualified education expenses, subject to income limits.
• Low Risk: Backed by the U.S. government, making them a low-risk option.

Cons:

• Lower Returns: Typically offer lower returns compared to other investment options.
• Purchase Limits: There are annual purchase limits for savings bonds.

Roth IRAs: The “Retirement Savings, but with a Twist” Option

Roth IRAs are typically associated with retirement savings, but they can also be used for college savings. Think of it as a Swiss Army knife—versatile, but with some limitations.

Pros:

• Tax-Free Withdrawals: Contributions are made with after-tax dollars, and withdrawals are tax-free if used for qualified education expenses (subject to certain conditions).
• Retirement Savings: If not used for education, the funds can be kept for retirement.

Cons:

• Contribution Limits: Annual contribution limits are relatively low ($7,000 in 2024).
• Income Limits: There are income restrictions for contributing directly to a Roth IRA.
• Early Withdrawal Rules: Earnings must be held for at least 5 years and may be subject to taxes and penalties if withdrawn before age 59½ for non-education purposes.

Custodial Accounts (UGMA/UTMA): The “Flexible But Complicated” Choice

Custodial accounts under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are like the “choose your own adventure” books of savings accounts. They give you flexibility but come with some quirks.

Pros:

• Flexibility: No restrictions on how funds are used; they can be spent on anything the beneficiary needs.
• No Contribution Limits: You can contribute as much as you want.

Cons:

• Tax Treatment: Earnings are taxed at the beneficiary’s rate, which can be higher if the beneficiary is in a higher income bracket.
• Control: Once the child reaches the age of majority (usually 18 or 21), they gain full control of the funds, which might not be ideal if they’re not financially savvy.
• No Tax Benefits: Contributions are made with after-tax dollars and do not offer any special tax advantages.

Coverdell Education Savings Accounts (ESA): The Boutique Option

The Coverdell ESA is like the boutique college savings account, offering a bit more flexibility in terms of investment choices but with a few more restrictions.

Pros:

• Wide Range of Investments: You can invest in almost anything—stocks, bonds, mutual funds, and even real estate (within reason).
• Tax Benefits: Earnings grow tax-free and withdrawals are tax-free for qualified education expenses.
• Use for K-12 Expenses: Coverdell ESAs can be used for K-12 education expenses as well as college.

Cons:

• Contribution Limits: You can only contribute up to $2,000 per year per beneficiary.
• Income Limits: Contributions are phased out for higher-income earners.
• Age Restrictions: Funds must be used by the time the beneficiary turns 30, or they’ll face penalties.

529 College Savings Plans: The VIP Lounge

The 529 College Savings Plan is the crème de la crème of college savings accounts. Named after the section of the Internal Revenue Code that created it, this account is like the VIP lounge at the college savings club. It offers tax-free growth and withdrawals when used for qualified education expenses.

Pros:

• Tax Benefits: Earnings grow tax-free, and withdrawals are tax-free when used for qualified education expenses.
• High Contribution Limits: You can contribute a substantial amount each year—up to $15,000 per beneficiary per year without incurring gift tax (in 2024).
• Flexibility: Funds can be used for tuition, books, room and board, and even some K-12 education expenses in certain states.
• Since the Secure Act 2.0, unused funds can be rolled into a Roth IRA for the beneficiary.

Cons:

• Investment Choices: Investment options are often limited to a select range of mutual funds or other investments.
• Penalties: Non-qualified withdrawals come with a penalty and taxes on earnings.

Other Alternatives.

We occasionally see 2 additional alternatives that can work if implemented correctly, the use of life insurance and real estate.

Life Insurance: The Anti-Dave Ramsey special

All joking aside, Dave hates this option, but it can work, and has worked for many people. Using permanent life insurance, ideally in the child’s name, is a great way to access capital with little to no tax consequences

Pros:

• Tax Benefits: Earnings grow tax-free, and withdrawals are tax-free up to basis and then loans on top of that.
• High Contribution Limits: Contributions can be unlimited, subject to underwriting limitations and age.
• Flexibility: Can be used for any expenses. Can also be saved for later in life and the insurance is there forever.

Cons:

• Growth: Particularly in the early years, the majority of the contributions are eaten up by the cost of the insurance and the commissions to the insurance company.

Real Estate: The ‘Your Roommates pay for College’ Plan

Purchasing real estate in a college town can be a beautiful way to fund education. Your kid can live there during school and the rent paid by his/her roommates goes to pay for all of their expenses. It also provides a place to crash during football season. On top of that, the assets can continue to provide income and growth after your kids trash it and finally graduate.

Pros:

• Tax Benefits: Potential Deductions. Tax-free growth and appreciation.
• No Dorm costs.
• Real Asset. Unlike savings accounts, this one isn’t ‘used up’.

Cons:

• You better hope they go to school where you purchased the real estate.
• Typical landlord headaches