Making the Grade for Financial Decision Making - Content
by Jeffrey R. Lippman, CFP, ChFC
on April 1, 2015
New tidings are at our firm’s door steps as we begin a new year. For starters, we initiated a blog to coincide with our new financial planning website. Even more exciting was that two of our planners were expecting a child in the beginning of the year. This fact, while exciting, made us consider how much we would eventually need to spend on college tuition. Accordingly, it seems timely to discuss how one may strategize for such a significant financial goal.
According to Bloomberg, the average annual cost of private college including room and board was $42,419 in 2014 while inflating at a pace more than twice that of the inflation measured by the consumer price index. By applying a 3% inflationary adjustment to this expense, we can calculate a hypothetical first year college education expense of $72,215 in eighteen years from now. Add three more years to the expense with inflation and you’ll have a total savings goal of $302,121, and for the most expensive private colleges, that goal could be much higher. Saving for college is a daunting savings goal that appears to be only getter harder to achieve.
Provided there is a desire to fully fund a college education, here are three distinct strategies to consider:
- Implement a college savings funding vehicle with periodic contributions, i.e. 529 Plan
- Save through a general, non-qualified brokerage account
- Engage Comprehensive Financial Planning
Open a college savings account
As per Kiplinger, one can identify 5 “smart” savings strategies for college expenses. But which one works best? Each carries advantages in the hopes of adequate growth and tax shelter along with disadvantages such as market volatility and potential tax penalties. A 529 college savings plan, for instance, is a tax-advantaged college savings vehicle supporting a spectrum of investment options that can grow tax-free. Upon need, these assets could then be withdrawn tax-free for qualified education expenses. Also, in some states, contributions to 529 plans within that state of residence can be deductible from state taxes, with limits.
If distributions are not used for education costs, federal law could impose a 10% penalty on the earnings and those earnings could be taxed at ordinary income rates. What if the child were to qualify for a scholarship or never attend college? Although the assets are transferrable to other beneficiaries within limits, distributions for non-qualified expenses could result in significant tax penalties and taxes. Invariably, planning for a child to attend college 18 years in advance requires a bit of guess work.
Open a non-qualified brokerage account for multiple objectives
Out of caution for choosing incorrectly, it could prove wise to postpone saving directly for college expenses and rather pool available savings into a non-qualified brokerage account. Taxes on dividends/interest could be minimized by focusing on investments that primarily grow by capital gain or through tax-free municipal income. Then, at a later date, make a more informed decision on funding as to: implications of your adjusted gross income (tax credits), child’s likeliness to attend college and/or receive a scholarship, availability of college loans and qualifications, more predictable cost of tuition, or maybe a reconsideration of committing to paying for a four year degree.
But, if that savings goal of $302,121 is ugly today, how would it look in 10 years, unfunded? One could just transfer some of the accumulated assets from the non-qualified account to pay for college expenses. However, careful discipline must be employed to ensure that the use of the monies for college tuition from the non-qualified account does not adversely affect other saving objectives, such as saving for retirement or the purchase of a new home. Here is where coordination of savings for financial goals is key.
Coordinate decisions via comprehensive financial planning
Deciding unilaterally from what account one can save for college savings (whether through a separate or general account) weighed against the decision to engage comprehensive financial planning is a quantum leap. One is simple, segmented, and non-committal while the latter is complex, holistic, and time consuming. Comprehensive Financial Planning, as defined by the CFP Board is “… the process of determining whether and how an individual can meet life goals through the proper management of financial resources.” A well-constructed financial plan individualizes for each person a totem pole of financial priorities (retirement, college savings, debt reduction, etc.), so one may confidently allocate limited resources in a tax efficient manner. Financial planning does not mean you will necessarily start saving for college expenses but it will identify its priority compared to other financial objectives and then provide viable, tax-efficient means of achieving each objective in order of those priorities.
Comprehensive financial planning offers a clear picture of not only your financial circumstance but more importantly, your financial options. The lens provides superior clarity to your situation along with a flash of reality that adjusts accordingly so you need not wait until the perfect light. But this allegoric camera comes at a price. A qualified, knowledgeable planner could spend weeks preparing, analyzing, and presenting your situation with objective options and solutions. The investment of hiring an advisor to do it for you is often a percentage of your total working capital (savings) and income.
As with most decisions, there is not a one size fits all solution. I do, however, believe it is best to consider financial planning whenever facing a financial decision, whether simple or complex. We may just want to find a college savings option that appeals to our senses, but in doing so, we often ignore the full effect of that option onto our financial future and how our financial future affects our college savings option. Understanding ones cash flows, tax circumstances, cash liquidity, investment goals and risks, and integrating saving considerations make the college savings objective far easier to achieve. By excluding these considerations, we ignore key information and apply guesswork where it could have been avoided. If, however, we understand our goals, our decisions, and how each decision may affect the goals, we may limit mistakes and forge ahead with confidence. To this endeavor, nothing can be more apropos than planning for college savings with an educated decision.
The information is the personal views of Jeffrey Lippman and is not necessarily indicative. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed here are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected.