Have you seen how expensive college is getting these days? If you’re a parent, setting up a college fund for your kid is more important than ever, unless your plan is to cross your fingers for a sports or academic scholarship. But if you’re not forcing your kids to put in 10,000 hours on the piano, the baseball diamond or the debate team, starting a college savings fund might be the smartest thing you can do now to make sure your kid gets smart down the road.
But you have questions. How do you open one? How do they work? How do you invest the money? If your kid doesn’t go to college — or gets a full-ride scholarship — what happens to all that money that’s been collecting, interest-free, for years? We worked with a financial adviser at Edward Jones who opens college funds all the time (and who, for legal reasons, we aren’t allowed to name) to figure out the answers to all the questions you may have. Starting with…
Okay, I’m at square one. What exactly is a college fund?
It’s basically an investment account that you can put money into and out of, tax-free, to be spent on educational things. The money grows because it’s invested into places like the stock market or mutual funds.
Are there different types?
You betcha! There’s a 529, a Coverdell and a UGMA and UTMA (which stands for Uniform Gift/Transfer to Minor’s Act, respectively). Coverdell, UGMA and UTMA are all custodial accounts for minors, which means your kid gets control of the money when they turn 18. You can also spend the money on elementary or secondary schools — not just college. With a 529, however, you — the parent — remain the primary account holder and control the money permanently. While money in a 529 is historically meant for higher education, as of this year you can spend up to $10,000 per year on private elementary or secondary schools.
So it kinda takes some guesswork about the future to decide which to go with, right?
What doesn’t? But yeah. Do you see private school in your kids’ futures? Are you gonna want to entrust the money to them someday, or keep control of it? These are things you’ll have to take your best guess at.
How do I set one up?
Through a financial adviser is the safest way. Like with lots of financial stuff, you can learn about this on your own if you want to do the work and can set up the account though an online brokerage firm, but it’s probably best to talk with an adviser.
How do you choose where the money gets invested?
Coverdell accounts let you invest the money any way you want, while UGMA/UTMAs have rules against certain high-risk investments. The way a 529 (and usually UTMA/UGMAs) works is, most brokerages have a long list of pre-approved mutual funds and stock market funds you can choose from, complete with a big, boring pamphlet explaining each of them in numbing detail. Again, if you relish the ins and outs of investing, knock yourself out and enjoy the ride. If not, it’s best to talk to an adviser.
As with any financial planning, a diversified portfolio is essential, as is making plans to move your higher-risk investments into lower-risk investments a few years before you plan on withdrawing the money (in case the stock market nosedives as soon as your kid enrolls). By design, though, most of the funds you can choose from are pretty safe, since college money shouldn’t carry the same kind of risk as a Vegas sportsbook.
Does it have to just be me and my partner contributing? Or can my rich brother put money into my kid’s college fund?
Yeah, anyone (even corporations) can contribute to it. Start buttering him up now!
How much can you put in?
With a 529, any individual can put up to $15,000 per year into it. UGMAs/UTMAs have no limit. With a Coverdell account, it’s capped off at the relatively low $2,000 per year, but again, the advantage — if you’re good at this stuff — is that you can invest the money any which way you want.
What if my kid wants to apply for financial aid?
Yeah, about that: A college fund could definitely affect your kid’s chances of qualifying for aid. UGMA/UTMAs have a bigger effect on their chances of receiving aid than 529s and Coverdells, because colleges view them as the child’s asset (since they’re technically in possession of the money). 529s and Coverdells also aren’t reported as assets on a FAFSA (the form you fill out to request financial aid) so they’re less likely to interfere.
What can a college fund pay for? Is it just tuition fees?
Nope! It covers tuition, but also supplies, including computers, internet access and certain computer essentials (e.g., a printer, but not a video game). It also covers room and board, although the exact amount can get complicated. It won’t cover furniture, never mind a flat-screen TV.
Say my kid doesn’t go to college, for whatever reason. What happens to all that money?
With a 529, since you’re in control of the money, you can change the beneficiary to anyone else — like to your other kid, or even to yourself, if you wanna get a master’s degree. Hypothetically, if you want to study music or golf or whatever (at an accredited college), you could conceivably also spend it on “supplies” like nice instruments or new golf clubs. The same is true of the other kinds of accounts, too, but since the money is theirs, the decision about what to do with it is theirs, too.
See, the whole point of a college fund is the U.S. government encouraging (in the form of tax savings) people to go to college — those are basically the IRS’s rules of the game. If you don’t spend a college fund on education, they’ll tax it, and slap on a 10 percent penalty fee. If it’s any consolation, look at it like this: If your kid doesn’t go into higher education, at least that college fund money isn’t trapped. More like… held for ransom. And if a vocational or trade school is more your kid’s thing than college, you can still spend what’s in your college savings account toward that, tax-free, so long as the school is accredited accordingly.
At the end of the day, so long as you know the rules, you can do a lot with a college fund. Or, what the heck, you can bite that penalty bullet and just blow it all on hats.