A new school year is in full swing and, as anyone with a student off to college for the first time can attest, the expenses will be substantial and ever-increasing.
Hearing the war stories of their neighbors can trigger some understandable panic on the part of parents with young children. Saving for college is neither as simple, nor as effective, as it used to be. Unique strategies may be the only way to afford higher education.
"It is the biggest expense our clients will incur, second to the purchase of their home," says Denis Horrigan, CFP, a partner at Connecticut Wealth Management, a firm offering financial planning and asset management through LPL Financial that actively manages more than $200 million in client assets.
Horrigan estimates that a family with three children may expect to find the cost of a private institution will cost upward of $800,000 before scholarships, grants or aid kick in.
Several challenges confront families, even if they start planning while their kids are young. A short time horizon escalates the pace of saving and makes down market cycles potentially devastating. The rising cost of secondary education also makes the savings goal a moving target.
Horrigan draws a comparison between saving for college and planning for retirement.
"When you are saving for retirement, what you are trying to do is grow your assets at a rate that's greater than the general inflation rate," he says. "Well, when the general inflation rate is 3% that's attainable. With the inflation rate of college education at about 6% a year, that becomes your hurdle. If you are putting money in a savings account earning 1%, you are going backwards. Your best option is to utilize some sort of investment vehicle."
Increasingly, new solutions are being offered to help families save for college.
Since the 1990s, states have offered 529 Plans, tax advantaged investments (the earnings grow tax deferred) that o! perate s imilar to how a 401(k) or IRA does. Each state has retained firms that manage an investable slate of funds. Investors are not limited by geography when choosing to establish a plan.
Even though asset levels took a major hit during the recession, eroding a large chunk of many families' savings right as their children reached college age, the plans remain popular and their use is growing.
Assets of 529 college savings plan rose in the second quarter of 2011 to reach $149.8 billion, up 2.4% from the first quarter and 27% from $117.6 billion a year earlier, according to research by Financial Research, a financial services consulting firm in Boston, and the nonprofit College Savings Foundation.
Competition among states has led to some creative approaches by the plan providers.
In Arkansas, for example,
BlackRock(BK) offers -- through financial advisers -- the iShares 529 plan, the only 529 plan made up solely of ETFs as the underlying investments.
The plans offer a variety of customized portfolios based on a target date of the student starting college.
In April, a report by FRC and CSF said index funds represent the fastest-growing segment of 529 plan options.
According to the report, CSF members (who manage between 40% and 45% of overall assets in the 529 industry) reported that, as of De. 31, more than $5 billion was invested in index options, a nearly 25% increase on an annual basis. This compared with assets under management increases of approximately 8% and 18%, respectively, for the population overall. BlackRock says the iShares 529 Plan has seen its assets double year over year.
Stephen Jobe, director of the iShares 529 Plan, credits the success and increased demand to the benefits of its ETF approach, notably transparency, low cost and the avoidance of "style drift."
The holdings are all based on popular and recognized indices, and daily updates are o! ffered o nline. The funds closely follow certain indices, providing access to specific sectors and asset classes while remaining "consistent with the portfolio's objective," Jobe says. The traditional mutual funds held by 529 plans may disclose their holdings as infrequently as twice a year.
According to the FRC/CSF report, the industry average annual asset-based fee for adviser-sold 529 Plans was 1.16%, compared with 0.62% for the iShares 529 Plan. Because the plan is available only via fee-based financial advisers, there is an added cost that directly sold plans don't incur. A full breakdown of fee comparisons is offered online by BlackRock.
There are other savings approaches aside from 529 plans. Establishing a Roth IRA is one vehicle that may not spring to mind as an immediate option.
"There are limits to contributions and so forth, but a Roth IRA is one way a parent, particularly depending upon their income bracket, could put money aside and make the decision, when the time comes, to either use it for their own retirement or withdraw the principal amount tax free and utilize that for college expenses," Patti says.
For grandparents, as well as other family members or friends, lending a hand needs to be carefully considered.
When it comes to financial aid applications, federal documents ask only for an accounting of assets held by the student and his or her parents.
"At no point on this financial aid application does it ask about the assets of grandparents," says Patricia Kane, CFP, senior financial adviser for Connecticut Wealth Management.
So are the 529 savings donated by grandparents effectively shelters and hidden from view?
"We always use some kind of caution here in that at the federal level they may not be asking for it, but the individual schools themselves might ask if there are any college saving in the student's name outside of they and their parents," Kane says.
Grandparents, and othe! r relati ves, may want to consider 529 plans as an estate planning tool.
"One of the strategies that planners will suggest to folks of high net worth is to gift assets out of their estate to other people," Horrigan says. "So a 529 plan is essentially a gift from the grandparent to the grandchild, for example. It is the only tool we are familiar with that actually allows the grandparent to make an irrevocable gift to someone else, in this case the grandchild, but still have control over it. They have control in terms of how the money is invested and over who uses the money because the money can slide from sibling to sibling within a family. Normally in estate planning when you make a completed gift you give up all control of that money."
Horrigan says another approach, the most direct, is to simply cut a check.
"It isn't really a plan, in fact it is the absence of one in many ways," he says. "The federal government tells us how much money we can give to any one person before there are gift taxes due. However, that same grandparent, who is limited to giving a certain amount of money to their grandchild in a given year, can directly pay the full bill for that child's tuition, room and board, and expenses. Whereas they can only give $13,000 this year, they could write a check for $55,000 to Harvard and there is no gift tax due."
It is uncommon to see an entire tuition bill gifted as such, though, Horrigan says. Typically a partial payment is made directly to the school.
Students saving on their own are at a disadvantage. Any money they save and invest could work against them when financial aid is calculated.
"For every dollar that you have saved in assets, the federal government assumes that up to 36 cents of that dollar can be spent on college," he says, explaining the financial aid eligibility formula. "When your parents have a dollar saved, only six cents is assumed [available for spending on a] college educati! on. The worst place to save money and still qualify for student loans and grants is in the student's own name. The best place is in someone else's name."
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