College Planning Archives - Uplevel Wealth

How to Save and Invest for Kids

As new babies are born, summer job paychecks roll in, and high school graduates gear up for college in the fall, many parents ask themselves what they should be doing today to set their children up for future financial success.

The options available today go far beyond a simple savings account at your local bank or credit union, and the savings and tax benefits can be immense.

The first step is to determine what your financial goals are for your child – whether it’s saving for college, building a nest egg for a future purchase like a car or a home, or even their eventual retirement. Depending on the answer, there’s an account that will work for you, and it’s never too early to get started.

Saving for College:

With costs skyrocketing over the last two decades – average tuition and fees at 4-year public colleges rose 69% between 2000 and 2020 – saving early has become necessary. A family with a baby born this year would need to save $250 per month to fund in-state tuition at a public college or university, and the amounts for an out-of-state or private college are even more staggering.

529 College Savings Plans and Coverdell Education Savings Accounts (ESAs) are two options designed explicitly for educational savings.

529 College Savings Plans

The popularity of 529 plans has taken off dramatically since their introduction in the late 1990s, and they remain a powerful way to save for college.

529 programs are managed on a state-by-state basis, where each plan has its own options and rules. Generally speaking, one can invest in any state’s 529 plan, but it makes sense to research your home state’s program first to see if special tax advantages are available to residents. For example, Oregon’s College Savings Plan offers an income tax credit of up to $170 for single filers and $340 for joint filers.

Contribution limits are high for 529 plans, with deposits of $17,000 or less falling under annual gift exclusion rules. Deposits over $17,000 can be made if the IRS Form 709 gift tax return is filed. Oregon restricts additional 529 plan contributions once an account balance reaches $400,000, but the account can continue to grow via its investments.

In any state’s 529 plan program, the main benefit is powerful tax savings. As long as funds are used for qualified college expenses, there is no state or federal income tax on investment growth or withdrawals. Starting a 529 plan for a newborn or young child allows for years of potential compounding, one of the best ways to build a nest egg for future college costs.

Private College 529 Plans

The Private College 529 plan is different from traditional 529 plans. The plan launched in 2003 to make private schools more affordable by locking in tuition at current prices. Parents can put money into an account over a plan year, from July 1 to June 30th, and receive prepaid tuition certificates at current prices. When your kids are ready to enroll at any of the nearly 300 member colleges, no matter how much tuition increases, the member colleges guarantee the rate you lock in. What you save on tuition is tax-free.

There are a few catches, however. The tuition certificates are not redeemable for 36 months after the first deposit, your child may or may not attend or get into a member school, and you forgo the potential bigger upside of a traditional 529 plan, which gains value when the market rises.

Some families may hedge their bets by enrolling in a traditional 529 and private 529 plan, as traditional programs offer more flexibility and greater coverage, including room and board. Private prepaid plans only cover tuition and fees.

Coverdell Education Savings Accounts (ESAs)

Once known as Educational IRAs, Coverdell Education Savings Accounts (ESAs) have positives and negatives. On the plus side, ESAs offer great flexibility in the educational expenses they can be used for. Funds can be withdrawn to pay for qualified expenses from kindergarten (public, private, or religious schools) through college. Investment options are flexible (mutual funds, exchange-traded funds, individual stocks), and growth and withdrawals are tax-free if expenses are considered qualified. ESAs are not considered an asset of the child regarding financial aid calculations.

Now for the negatives… Contributions to ESAs are limited to $2,000 per child annually and subject to income restrictions. Joint filers with modified adjusted gross income (MAGI) up to $190,000 can contribute the maximum yearly amount. Those with MAGI between $190,000 and $220,000 can make a reduced contribution, and incomes above $220,000 are ineligible. Unlike a 529 savings plan, an ESA must be distributed when the designated beneficiary reaches age 30 unless they have a disability.

If you’re ready to turbocharge your college savings or want to save for both elementary and secondary education expenses, contributing to both a 529 plan and ESA is allowed.

Saving for General Use:

As any parent or grandparent can attest, there are still plenty of kid-related expenses to save for – cars, summer camps, or expensive club sports – aside from education. Custodial accounts (established under the Uniform Gift or Transfers to Minors Acts) are a flexible way to save while benefiting from an investment portfolio’s growth.

While the child is a minor, a parent or other adult will act as the account’s custodian, with the child as the beneficiary. Contributions are an irrevocable gift to the child, and withdrawals must be used for the child’s benefit. There is no maximum contribution amount or account balance, but gifts over $17,000 in a single year are subject to IRS gifting rules and reporting.

Unlike the flexibility of a 529 plan or ESA, the beneficiary of a custodial account cannot be changed. Depending on the rules of the state in which you reside, the account will terminate when the beneficiary turns 18 or 21, and funds will be at their discretion. If the thought of a teenager or early twenty-something gaining control of a pool of money makes you nervous, you’re not alone! For significant dollar amounts, establishing a trust for the child’s benefit, with the ability to set tighter restrictions, may be the better way to go.

While offering much greater flexibility in using funds, custodial accounts have some financial considerations. According to “kiddie tax” rules, the first $1,250 of investment earnings per year are exempt from tax altogether, the next $1,250 is taxed at the child’s rate, and anything over $2,500 is taxed at the parent’s tax rate.

Regarding financial aid calculations, custodial accounts are considered assets of the child and weighed more heavily, with federal financial aid formulas counting up to 20% of the balance as available for college expenses.

Saving for Retirement:

Though retirement is many decades away for a young child or teen, if your child has earned income from a job, with a W-2 or 1099 as proof, contributing to a custodial Roth IRA is an incredible way to save.

Like a regular custodial account, a custodial Roth IRA is established with a parent or other adult as custodian and the working child as beneficiary. Annual contributions are limited to the lesser of the child’s calendar year work income or $6,500 and can be made until their tax-filing deadline in April.

Just like a regular IRA, a custodial IRA can be invested in stocks, mutual funds, ETFs, and more, and it is a great way for a kid to learn more about investing.

Though intended for retirement, withdrawals of contributions can be made anytime. Withdrawals of earnings may be subject to taxes and penalties if the account hasn’t been open for at least five years. Withdrawals for certain exceptions may not be subject to tax or penalties, such as a first-time home purchase, qualified educational expenses, or disability.

The main advantage of a Roth IRA is that it grows completely tax-free, and withdrawals are tax-free as long as they’re made after age 59 ½. For a young child, decades of tax-free growth could be worth a significant amount by the time retirement rolls around.

It’s Never too Early to Start

We’re probably all familiar with Einstein’s wise statement about interest being the 8th wonder of the world and the power of compounding over time. This is never more true than with the opportunity to save for your children’s future, and thankfully there are ways to do it that align with various needs.

If you’re unsure what type of account is best for your child’s situation or want some guidance on getting started, reach out. We’re here to help.

Uplevel Wealth is a fee-only, fiduciary wealth management firm serving clients in Portland, OR and virtually throughout the U.S.

What The Secure Act 2.0 Means For You

At the end of 2022, the Consolidated Appropriations Act was passed, which included a retirement bill known as SECURE Act 2.0. This law was built upon the original SECURE Act legislation passed in 2019.

The SECURE Act 2.0 expands and changes the rules on saving for retirement, withdrawals from retirement plans, increases the savings thresholds and tax benefits for Roth IRAs, 401(k) plans and more.

Ultimately, most people just want to know what parts of the Secure 2.0 Act apply to them. Here’s a summary of key provisions to pay attention to.

High Wage Earners & Catch-Up Contributions

Catch-up contributions allow folks 50 and older to save even more in workplace retirement plans.. For 2023, the catch-up contribution was raised to $7,500. This is in addition to the regular annual contribution limit of $22,500, meaning those 50 and above eligible to save $30,000 in total for 2023.

Effective in 2024, people with wages (like w2 income) above $145k (which will be indexed for inflation) are only eligible for Roth catch-up contributions. Regular contributions may still be made with pretax dollars. The new rules apply to 401(k), 403(b) and 457(b) plans, not to catch-up contributions for IRAs. The IRA catch-up contribution limit will finally adjust automatically for inflation from its stagnant $1k cap in 2024 as well.

Planning opportunities: You may be able to avoid mandatory Roth 401(k) catch-up contributions with income above $145k if you are self employed. Also, if you change jobs in the middle of the year, you may still be able to do pretax catch-up contributions even if you’re a high wage earner.

Roth-Related Changes

If you’re an employee with an employer-sponsored retirement plan, you’ve only been able to receive matching contributions on a pre-tax basis. Employers may now offer the option to match and make non-elective contributions via Roth 401(k) accounts. Heads up: You’ll also pay taxes on these employer contributions.

Beginning in 2024, employer retirement plan based Roth accounts like Roth 401(k) and Roth 403(b) will no longer require RMDs, similar to individual Roth IRAs. SEP and SIMPLE IRAs will now allow Roth contributions.

Good news: One component that was not restricted or eliminated was existing Roth strategies, like backdoor conversions or mega-back-door Roth contributions.

Additional Flexibility for 529 College Savings Accounts

Beginning in 2024, it’s possible to move money from a 529 plan directly into a Roth IRA, and the transfers are not subject to income limitations. This comes as great news for savers who had concerns about potentially overfunding their child’s 529 plan. There are, however, certain conditions that must be met:

The Roth IRA receiving the money must be in the same name of the beneficiary of the 529 plan;
The 529 plan must have been maintained for at least 15 years;
The annual limit is the IRA contribution limit for the year, reduced by any regular IRA or Roth IRA contributions made that year;
Lifetime transfer limit of $35k

Planning opportunity: If a parent contributed to a 529 account for their child, maintained ownership, and the child no longer needed the 529 money, it appears the parent may be able to change the beneficiary to themselves and then transfer the money to their own Roth IRA, subject to the conditions above. Note: Before doing so, please seek expert guidance. Some legislation interpretation still needs to be confirmed or rejected.

Changes to Qualified Charitable Distributions (QCDs)

QCDs have been one of the best ways for people who are charitably inclined to give money directly from an IRA in a tax-efficient manner. The annual limit of $100k will now be indexed for inflation starting in 2024.

It’s also now possible to use a QCD to fund certain types of charitable trusts. However, the maximum amount that can be moved is $50k. Given the time, expense and complexity that comes along with these types of trusts, this modest dollar limit may preclude most people from doing so.

Changes to Required Minimum Distributions (RMDs)

RMDs are when you must take withdrawals from your retirement accounts, regardless if you want or need the money. The original SECURE Act raised the age for RMDs from 70.5 to 72. SECURE 2.0 pushes this out further:

Age 73 for folks born between 1951–1959
Age 75 for folks born in 1960 or later
Turned 72 in 2022 or earlier? You must still keep taking RMDs.

The bill also decreases the penalty for missed RMDs from 50% to 25% of the shortfall, and providing the mistake is corrected in a timely manner, the penalty is now only 10%.

Have a younger spouse? If they predecease you, you can now elect to be treated “as your deceased spouse,” which allows you to take RMDs based on their age rather than your own.

Planning opportunities: Pushing out the extra income created by RMDs age could mean additional years before the dreaded spike inMedicare Part B/D premiums and perhaps a few more years of Roth conversions. Please work closely with your advisor to see if this applies to you.

Other Changes Worth Noting

At over 400 pages, the legislation is long and cumbersome. While it’s impossible to include every component, we’ve focused on the items that are most likely to impact our clients. A few other items worth noting:

In 2028, some S Corp owners who sell shares to an Employee Stock Ownership Program (ESOP) may be eligible to defer up to 10% of their gain by taking advantage of a like-kind exchange;
SECURE 2.0 expanded the list of 10% penalty exceptions for accessing retirement funds during times of need;
Beginning in 2024, employers can “match” an employee’s student loan payments by contributing an equal amount to a retirement account on their behalf.

3 Ways to Uplevel Your College Planning

THERE’S NO SINGLE, right way to legally crack the college admissions and financial aid systems. It’s up to teenagers and their parents to do the necessary work.

Still, it helps to have a tour guide—which is what you get with The Price You Pay for College, the new book from New York Times financial journalist Ron Lieber. Lieber’s book discusses why college costs so much, digs into the allure of elite schools, uncovers hacks that may not really be hacks, and talks about how to plan and pay for college. Here are three key ideas that I took away from the book:

1. Families need to talk. Teenagers and their parents should discuss money, core values and priorities. That’ll help students identify what they want from their college experience.

Sprinkled throughout Lieber’s book are thought-provoking questions. For example, what’s your definition of success? What is college for? Is it about learning? Building connections? A means to a job? If a college education is a means to a job, at what price? What can the family afford? Where will the necessary money come from?

If the value of a college education to your family is a job, you might wonder just how important an elite school is for obtaining a more coveted position. Lieber’s research suggests it’s not as critical as you may imagine, with alumni from top schools obtaining between 13% and 58% of prestigious jobs, depending on the occupation. What’s apparent is the benefit of the doubt accorded to applicants who have the most selective schools on their resume. Certain gatekeepers have a vested interest in continually building and promoting their own networks, which can often start with their alma mater.

Lieber doesn’t pretend to have a formula that calculates the actual value of any given college experience. Instead, he encourages us to reflect on how our feelings influence such an important and expensive decision. In his decades of reporting, Lieber “has never come across a consumer decision that inspires more confusion and emotion than this one.”

2. The devil is in the details. Once you outline what you’re looking for from the college experience, start digging for data. Lieber’s book offers resources to help uncover the data that does exist. One problem: The numbers aren’t standardized across schools and aren’t always easy to come by or interpret. For example, mental health is becoming more top of mind for many families, with nearly a quarter of new undergraduates now classified as disabled, largely due to a mental health diagnosis such as depression or anxiety. Campus resources may be very important to these families, so it’s worth determining how long it takes to schedule an appointment for counseling, who the providers are and what type of support organizations are available.

The clearer you are on what success means for your child and family, and what value a college offers, the more you can cut through the clutter and eliminate details that aren’t a priority. In a decision that’s anything but easy, the more noise you can eliminate, the better.

3. The game has changed. It’s probably not that surprising—and yet still alarming—to learn that consultants play a big role behind the scenes. They help colleges to find students, to determine what to charge them and to prod families to follow through. Discounts to attract students are often offered in the form of merit aid.

It’s tough to understand the financial aid system, let alone predict how much merit aid you’ll receive—assuming, of course, you get in. Merit aid doesn’t consider your financial situation, like need-based financial aid does, so it’s entirely possible for wealthier families to be offered discounts, provided the student has what the college is looking for. Colleges use algorithms to predict what kind of discount is needed to get a particular student to say “yes.” This is all guided by consultants, who “help schools leverage information about your family to optimize your discount,” Lieber writes.

He gives us valuable hints about how to uncover more about merit aid than the basic information listed on a school’s website, and it starts with a school’s Common Data Set. The easiest way to find this information is by Googling “common data set” and a college’s name. Among other items, look for the number of people who received merit aid, despite no financial need, and the range of test scores for admitted students. If your student’s scores rank high for a particular college, there’s a greater chance of merit aid. Schools claim their award-giving process is based on more than test scores and other data, and it likely is. Still, checking the numbers gives families a shot at determining how a college’s algorithm is likely to rank their prospective student.

Want to talk more about your specific situation? Reach out to us today.

This article first appeared in HumbleDollar.