Education Planning

By Michael Foster, CFA, CFP®

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Education planning is one of the most interesting parts of financial planning to me.

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The time when many people prioritize education planning is often a time where their own competing financial goals are among their most pressing. If you have young children, buying a home, life and disability insurance, getting your basic estate planning documents completed, and saving for retirement can all be competing for your dollars and attention with saving for your child’s future education.  

Outside of goals, it can be hard to know where to even start. There are different types of accounts that differ in cost with different investment options that provide different benefits that can differ based on where you live and so on… not exactly easy to navigate! While I won’t be able to touch on all aspects of education planning in this article, the framework below is how we typically think about education planning with our clients. Please note, there are several generalizations here, and your own situation should be prioritized when education planning.

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Should We Be Education Planning at All?

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We often tell our clients that their children can borrow for education, but they can’t borrow for retirement. Before setting aside funds for education, it can be prudent to make sure that your own savings rate is on track to meet your retirement goals. An ideal savings rate is very dependent on what you want your retirement to look like and when you start saving. We typically advise that anything above 20% of gross income is a very healthy savings rate for retirement, but the amount needed can vary wildly by individual. To relate it to a line we’ve all heard, “make sure your own oxygen mask is on first before assisting others”. If you’re able to save for our own retirement goals with additional funds left over, education funding can be a prudent use of funds.

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What Type of Account Should I Use?

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The starting point we typically recommend is a 529 plan, but there are other types of accounts (Coverdell, UTMA, UGMA, etc.) that can be used for education savings or giving to a minor more generally. 529 plans are state-sponsored plans meant for saving for education. There can be tax benefits by saving in these accounts by allowing the earnings to be used for qualified education expenses free from federal and, generally, state tax. There can also be penalties for using the funds for non-qualified education expenses. Each state has a different plan, and based on where you live, there are different tax benefits to using your state’s plan. For instance, in North Carolina, the earnings used for qualified education expenses are free from state tax, but the contributions made are not tax deductible. Other states may have different rules that allow a certain dollar amount, percentage, or full contribution to be deducted. Different states also have different plan fee structures and investment options, so be sure to look (or have your advisor look!) at all your options.  

For clients with highly funded 529 plans, we sometimes recommend clients save additional funds in a separate taxable account from any brokerage account they may already use. This allows them to have a separate account earmarked for education but with the flexibility to shift the goal of the funds in the instance the client’s goals or situation change, a child receives a large scholarship, the child doesn’t attend college, or a host of other reasons. There is no penalty for shifting the goals or usage of these funds, but these funds also don’t have the same tax benefits of a 529 plan.  

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How Much Should I Save in These Accounts?

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For clients with a savings rate that allows them high flexibility, we ask them how they want their child’s education funding to go. Some prefer to pay for the entire bill for undergrad and graduate programs, others want their kids to have “some skin in the game”, and some prefer their kids figure it out for themselves. It just depends. For those that want to pay for a large portion, but not all, we conduct an analysis of what education is likely to cost based on an assumed education inflation rate, historical return rate based on a reasonable allocation, and current costs of education including tuition, room and board, and supplies. We can use costs from national averages or other criteria in case you think your child is likely to attend a specific type of school (ex. an expensive private college). From here, we run analysis using our planning software and work with the client to come up with what percentage of assumed cost should go in a 529 plan versus other accounts.  

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All in all, there are a ton of considerations when education planning. Be sure you have your financial goals prioritized, know the different accounts and options available to you, and conduct an analysis if you want to get specific on savings amounts. As always, let us know if we can be of assistance to you and your family’s education and financial planning needs.

**** Link 1: https://www.cfnc.org/news/how-does-an-nc-529-tax-deduction-work/#:~:text=Just%20as%20there%20are%20no,is%20taken%20out%20for%20education.

Link 2: https://smartasset.com/taxes/529-plan-tax-deductions-for-every-state

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