How To Save For a College Education

How To Save For a College Education

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You are probably expecting your children to go to college one day, and they probably should because college offers many benefits to those who attend and graduate.  College graduates earn more and spend less time unemployed than their counterparts without a college degree.  There are other lifelong benefits too, such as a network of friends and an appreciation of learning.

How much does college cost?  I think most people would say it is a lot, despite all of the benefits mentioned above.  Four years at a public college with in-state tuition could be as low as $60,000 in total, but private colleges could easily exceed $250,000.  And costs have been rising significantly faster than inflation.

Since college is going to be so expensive, you should start saving early.  But what is the best way to save?

529 Plans

The most well-known and widely used savings vehicle for college expenses is the 529 plan.  These are state-sponsored plans that allow investment gains to be tax-free if withdrawals are used for qualified college expenses.  The contribution limits are high and some states offer a tax deduction for contributions, up to an annual limit.  No state imposes a contribution limit based on income, and the owner retains control of the account, including investments and distributions.  In addition, because the account belongs to the owner and not the student beneficiary, the existence of the account has a limited effect on financial aid.

However, you are limited to investing in the available funds offered by the state and in order to get a state income tax deduction for contributions, most states require that the money be invested in their plan.  So if you are a NY state taxpayer and would like the deduction (for state purposes, none is available for federal purposes) you must contribute to one of two NY state plans.

Custodial Accounts

Custodial accounts, or UGMA and UTMA accounts are another way to accumulate money in a tax-advantaged way.  The first $1,100 of earnings realized in any year is not taxed, and the next $1,100 is taxed at 10% federal.  And you can invest in virtually anything, so if you want to buy only Amazon stock, you can do it with a custodial account.

However, the money belongs to the child and must be used for their benefit.  Once they reach age 18, or 21 in some states, they can spend the money on whatever they want, not what the parent wants.  Also, because the money is the child’s, a custodial account will more significantly reduce financial aid than a 529 plan.

Coverdell Accounts

The Coverdell account is very similar to a 529, except that no state tax deduction is offered, the maximum contribution is $2,000 per year, and income must be below certain thresholds in order to be eligible to contribute.  The only advantage of a Coverdell relative to a 529 plan is the ability to use funds for any level of education.

IRA

You can withdraw money from your IRA and generally avoid the 10% early distributions penalty regardless of age.  However, you will pay tax on the withdrawals from a traditional IRA and tax on the withdrawals from a Roth IRA if they are made before you are 59.5 or the account was opened less than five years.

IRAs were created as a vehicle for retirement savings, so using funds for college may leave the owner with a deficiency in retirement income.  But if you find yourself in a situation where you cannot save in both an IRA and a 529, choose the IRA because of the added flexibility in the use of assets.

If the child has earned income, he/she can open an IRA regardless of age, but a Roth IRA will probably make more sense because a child’s income tax rate is likely to be low, minimizing the value of the tax-deduction of a Traditional IRA.

Taxable Accounts

If you are not using one of the vehicles above, you are using a taxable account.  Tax-advantages are limited and not geared towards education (i.e., municipal bond interest and lower capital gains rates), but the accounts are the most flexible in terms of possible investments and liquidity.

Borrowing for College and Other Financial Aid

The Free Application for Federal Student Aid, or FAFSA, is used to determine Expected Family Contribution, or EFC.  Colleges determine how much federal aid you’re eligible to receive using the EFC.  The calculation is fairly complex, but 50% of a student’s income above $6,400 is expected to be used towards his/her education, as is 20% of his/her assets.  For parents, the figure ranges from 22-47% of income and 5.64% of assets.

Since savings count far less than income for parents, parents should not forgo savings with the idea that it will be made up by the federal government.  If grandparents have saved money in a 529 for the grandchildren, they should not withdraw the funds to pay for college expenses until the Junior or Senior year of the student.  The reason for this is twofold:

  1. Withdrawals from a grandparent’s 529 is considered income of the student, reducing the eligibility for financial aid, but
  1. There is two year lag between income and asset reporting on the FAFSA form and the year in which aid is given.  If withdrawals don’t occur until the junior year, then the student’s high income for FAFSA purposes isn’t relevant since they have already graduated (hopefully).

Summary

Being able to save significant amounts towards your child’s college education is truly a luxury, because you should be saving towards your own retirement and other family expenses, such as a home, first, and those other savings goals could easily take up 15% or more of your income.   If you are not likely to receive any financial aid, then you will either have to decide how much you will spend from your assets and how much your children can afford to borrow or spend of their own money.

Securities offered through Kestra Investment Services, LLC.,(Kestra IS) member FINRA/SIPC.  Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.  J Matrik Wealth Management is not affiliated with Kestra IS, Kestra AS, or Five Star Professional.

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Should I Open an Online Savings or Money Market Account?

Should I Open an Online Savings or Money Market Account?

Online banks offer some of the highest savings and money market rates in the banking world but many individuals are still nervous or skeptical about sending their money over the Internet.  Yet today, opening an online savings account or money market account can not only get you a significantly higher rate, but it can come with a lot of convenience and control.

Higher Rates and More

The most often cited reason for opening an online savings account is that online banks can offer savings rates that are over 1% higher than those offline.  Without the need to absorb the costs of branches and branch employees to support, they can operate more leanly, passing their savings on to their depositors.  Even among online banks, there is a range of rates that reflects competing demands for deposit capital.  Competition has become so keen that many major online banks offer their highest rates with minimal or no deposit requirements.  

There are other very compelling reasons to move some of your money to an online-only bank.   Principal among these are 24x7 access to your capital through a website or a mobile app and expanded customer service phone hours.  In addition, some banks offer check writing and a debit card as part of their online account.  Most however still find it most convenient to tie their online savings account or accounts to checking accounts at banks with large branch networks, holding only the minimum required at those banks and transferring capital back in as needed to cover expenses.   

You can see all online savings account rates, balance requirements, and features on the here.    In the reviews section of the table, users comment on their experience with a particular online bank, allowing you to ask questions and read about others experiences with account opening, customer service, transfers, and more. 

Is Your Money Safe?

All of the online banks listed on BestCashCow are FDIC insured.  While being FDIC insured is not a guarantee that a bank is necessarily financial sound, it indicates that the Federal Reserve guarantees your money up to $250,000 in each ownership category.  

In addition, many of the highest paying online banks have been around for some time or are part of larger, better known parent organizations.  Large, well known banks like Goldman Sachs Bank, Barclays Bank Delaware (one of the largest banks in the world), Emigrant Bank, Capital One, and TIAA CREF have rolled out online offerings with higher rates than their offline divisions. 

Is it Convenient?

In general, with an online savings or money market account, you can access your money online all the time, and deposit and withdraw your money using electronic transfers.  Some banks such as Ally now offer remote deposit though the mobile app.  By connecting your online savings account to another account that you have at your main bank - usually a checking account - you can easily transfer money back and forth.  An electronic transfer can take about 2-3 days to be complete, but at some banks, such as Goldman Sachs Bank, they are effected instantaneously.  Banks often have a 5 to 10 day hold period during which money recently transferred electronically may not be withdrawn.   

Customer Service

Almost all the online banks have phone numbers you can call if you have a problem.  You can also send them contact them directly through their interface or by email.

Some Pitfalls

Some online banks have very high introductory rates for savings accounts.  While the rate is guaranteed for a very period of time, it ordinarily is reduced to a lower rate shortly thereafter. Opening an online savings account at one of these banks can be viewed as being equivalent to opening a short term CD while having the money liquid.  BestCashCow however recommends depositors avoid banks that engage in bait-and-switch tactics, and favor those online banks that have a history of remaining competitive and extending their best rates to their longest standing customers, as well as to their newest customers(Ally, Synchrony, Goldman Sachs).

Bottom Line

There are plenty of reasons to continue to do business with banks and credit unions with branch networks that are close to you.   In fact, some of these banks offer savings and CD rates better than the most competitive rates online, so you should always check the rates in your area.

Often, however, the easiest way to gain an extra percentage point or more is to open an online savings account.  They offer high rates, safety, and convenience to those willing to make the jump to cyberspace.  When you consider the value of compounding even an extra one percent annually, your money can really add up over time (see the BestCashCow compound interest calculator here to calculate how much more you could make).

Do you plan to open an online savings account soon?  If not tell us why by commenting below this article.


Savings and CD Rates Are Perking Up as We Head into Summer

Savings and CD Rates Are Perking Up as We Head into Summer

Rate information contained on this page may have changed. Please find latest savings rates.

Last Wednesday, the Federal Reserve raised the Fed Funds rate from a quarter basis point to a target rate of 1 to 1.25%.

The move was widely expected, and gives hope to savers who have endured savings rates below zero for the almost a decade.

As I noted in my commentary the last time the Fed raised interest rates in March 2017, the impact on savings and CD rates banks are offering in not necessarily immediate.  However, 5 days after the Federal Reserve’s move, we are seeing the leading savings rates and CD rates increase.   BestCashCow’s tables show the best online savings rates are now as high as 1.30%.   They also show the best online 1-year CD rates are pushing 1.50%, with the best 2-year rates at 1.80% and the best 3-year CD rates over 1.90%. 

BestCashCow's local tables may show that savings rates and CD rates are offered in your home area that are higher than those that you find online.

Should you Lock into a Short Term CD now?

At this time last year, 1-year CD rates were as high as 1.35%.  As those CDs become due, their holders have outperformed cash, and are in fact outperforming cash right up to maturity.

Inflation is contained.  To boot, energy prices are falling due to Trump’s errant energy policy and disastrous climate policy.   While the Federal Reserve is only predicting one more rate hike this year and 3 next year, the fall in the 10 year US Treasury rates early this month would seem to indicate that the market is certainly not predicting any dramatic rise in interest rates in the immediate or intermediate future.  Therefore, there is little risk in a 1-year CD here, especially if you can find one that has only a 3-month early termination fee if you need the cash back sooner.

As it does briefly and semi-annually (each December and June), Ally Bank has begun offering its 11-month no penalty CD.  This time the rate is 1.50% for those depositing $25,000 or more.   Unless our tables show a better local savings rate or higher locally offered CD rates in your home market, this offer might be worth taking a look at.