Hopes, Dreams and College Savings Solutions
By Roger Michaud
May 29, 2012
It’s one of those universal truths that from the day their babies are born (or even before they are!) parents are filled with hopes, dreams and fears for their children. Those hopes and dreams typically include a successful career, which often starts with a college education. The thought of a college education, however, can lead to one of parents’ biggest fears—not being able to foot the bill. Given the rising cost of college, financing a four-year (or longer) degree for one or more children can be a daunting prospect for parents juggling day-to-day living expenses while trying to save for other investment goals like their own retirement too.
In observance of 529 Day, the May 29th “financial holiday” celebrating the 529 college savings plan, Beyond Bulls & Bears tapped College Savings Foundation Chairman and Franklin Templeton Division Sales Manager Roger Michaud for the low-down on tackling this common conundrum.
529 – 101
A “529 plan,” legally known as a “qualified tuition plan,” can be sponsored by states, state agencies, or educational institutions. The name stems from a section in the Internal Revenue Code, similar to how 401(k) plans got their name. These programs allow parents, and even family and friends in some cases, help a beneficiary save for college.
One of the appealing features of a 529 savings plan is that money invested grows free of federal income tax until withdrawn for qualified higher education expenses, such as tuition, books, room and board. There may also be state tax benefits too, but there is no federal or state guarantee of investments in the plan. It’s important to remember that, as with any investment, principal value may be lost, and investing in the plan does not guarantee admission to college or sufficient funds for college.
Tax benefits may be conditioned on meeting certain requirements. Federal tax and 10% penalty and state tax apply to non-qualified withdrawals or earnings. Generation-skipping tax may apply to substantial transfers to a beneficiary at least two generations below the contributor. See the Investor Handbook for more complete information.
So, where to begin? These five key strategies can help you get started on a college savings plan:
1. Start early
2. Educate yourself
3. Utilize systematic investment programs
4. Ask family and friends to consider contributing
5. Think about working with a financial advisor
Michaud underscores that the sooner you start, the longer you have to reach your savings goal. So don’t procrastinate!
“When it comes to saving for college, you can’t start early enough. It’s been a particularly challenging time because the markets haven’t worked in favor of savers for several years. Many students are graduating with $100,000 or more in debt. The amount of college debt in the U.S. today exceeds the amount of credit card debt.”
When saving hasn’t been an option, borrowing for college has been a solution for many. You can see in the chart below how student debt has been growing. As of the third quarter of 2011, the balance of outstanding U.S. student loans stood at $870 billion, while total credit card debt stood at $693 billion.1
Sometimes borrowing is inevitable, but in addition to the burden of graduating in debt, students could face a potential increase in interest rates on some popular student loans. If rates do rise, it’s going to be even harder—and potentially even more expensive— for students to pay back debt. For those with young children, saving as soon and as much as possible may actually be the less costly alternative.
The chart below illustrates potentially how much less costly. In this hypothetical example you can see how investing now can translate into a substantial savings over borrowing later. The example assumes that in 18 years, it will cost you $245,0002 to send your child to college. You could wait until your child is 18 and borrow the money, paying interest for 15 years, or begin investing $579 monthly for 18 years, assuming a hypothetical return of 7% per year, before any applicable taxes.
Investment fees, expenses and taxes would lower the savings amount and increase the cost shown. Each Franklin Templeton 529 College Savings Plan account3 is subject to a $25 annual maintenance fee, an annual program management fee of 0.40% of assets, underlying fund expenses, currently up to 0.88% of assets, which may vary, and sales loads and annual and deferred sales charges, which vary by class of shares. See the Investor Handbook for more complete information. These expenses are not reflected in the illustration; if they had been, results shown would be lower. The borrowing example assumes a fixed interest rate of 6.80%. Source: Salliemae.com. Based on Stafford loan issued by Salliemae after July 1, 2006. Assumes borrower at some point consolidates all federal education loans into a Stafford Loan. Examples are illustrative only and are not representative of any particular investment. 529 plans do not guarantee your investment or any specific rate of return, and you may have a gain or a loss on the amounts invested. Qualified withdrawals from 529 plans may be subject to state taxes. The earnings portion of nonqualified withdrawals is subject to federal income tax, a 10% federal income tax penalty and possible state income tax and penalties. Periodic investing plans do not assure a profit and do not protect against loss in a declining market. Since such plans involve continuous investment in securities regardless of their fluctuating price levels, it’s prudent to consider your financial ability to continue making purchases through periods of low price levels.
One past criticism of 529 plans was that the investment choices were limited. Michaud notes that today’s college savings plans are more flexible, so you really have to educate yourself about what choices are available to you.
“In the past, the investment choices in 529 plans tended to be rather passive. Over a decade ago, there were one or two or maybe three investment options, primarily based on age. For example, when the child is 0-8 years you’d be in one type of investment, then at age 9 you move into another portfolio. Today, the choices are much more diverse, not only in terms of age ranges, but also in terms of diversification and risk-tolerance. You could invest in 100% of your assets in international stocks for example, or perhaps only FDI-insured vehicles.”
Utilize Systematic Investment Programs
Considering the costs involved, saving for college can seem a bit overwhelming. But it doesn’t have to be, says Michaud.
“You can’t really control the cost of college, but you can control how much, and when you start saving. Save until it hurts a little bit. When you look at these estimates of what you need to save for college it can seem hopeless. But think about what you can afford. Can you pay for half? Can you consider a less expensive college? Can your children help fund some of their own education?”
Let’s look at one more example of how even modest amounts of savings can add up over time (you like math problems, right?). Suppose you invest $5,000 at your child’s birth and not another dime. Assuming an annual rate of return of 6%, for example, you’d have $14,272 after 18 years. However, if you made an additional $100 contribution to your college savings plan each month for 18 years, you’d potentially have more than $52,000 in the account at this same rate of return.
This is a hypothetical example to represent the effects of compounding assets assuming an internal rate of return of 6%. Contributions are assumed at the beginning of the period. Initial investment made on the first day of birth; subsequent contributions of $100 are made on the beginning of each month. Principal and income do not vary. It does not reflect an actual investment or any taxes payable upon withdrawal. A periodic investment does not assure a profit or protect against loss in declining markets. Returns are not guaranteed and may be less than or greater than this example.
Ask Friends and Family
In many families, children are expecting to bear at least some of the cost of their education. And, while parents often seem reluctant to ask family for help, their children aren’t reluctant to accept it. The 2011 College Savings Foundation survey found that most parents (69%) were uncomfortable asking friends or family for monetary gifts toward their children’s college, but when students were surveyed, 72% of 16-17 year olds said they would rather receive money for education on special occasions than tangible gifts.4
The Foundation’s survey also found that parents who use college savings plans are more successful at financing their child’s college education than those who don’t: 76% of parents with 529 plans had saved more than $5,000 per child, compared with only 29% without such a plan. Moreover, 20.5% of 529 plan-holders saved between $25,000 – $50,000 per child, while just 4% of people without a plan had saved that much.
Work with an Advisor
The best approach for college savings is going to be different from household to household. To help plot a course of action that makes sense for your individual situation, consider talking to an advisor.
What are the Risks?
All investments involve risks, including potential loss of principal.
Investors should carefully consider 529 Plan investment goals, risks, charges and expenses before investing. To obtain an Investor Handbook, which contains this and other information, talk to your financial advisor or call Franklin Templeton Distributors, Inc., the manager and underwriter for the Plan at 1-800-818-4030. You should read the Investor Handbook carefully before investing and consider whether your, or the beneficiary’s, home state offers any state tax or other benefits that are only available for investments in its qualified tuition program.
1. Source: Federal Reserve Bank of New York: Quarterly Report on Household Debt and Credit, February 2012.
2. Source: The College Board, Trends in College Pricing, 2010. Projected cost upon child’s entrance to college for four years at a public college. Figure is based on the 6.70% and 5.22% 10-year average annual increase in historical public college costs and private college costs, as reported by The College Board for the 2010-2011 school year.
3. Offered and administered by the New Jersey Higher Education Student Assistance Authority (HESAA); managed and distributed by Franklin Templeton Distributors, Inc. an affiliate of Franklin Resources, Inc., which operates as Franklin Templeton Investments. No federal or state guarantee. Principal value may be lost and investing in the plan does not guarantee admission to college or sufficient funds for college. Please refer to the Investor Handbook for more complete information.
4 Source: College Savings Foundation, 2011 Survey of Youth.
(c) Franklin Templeton