Financial Literacy Archives - Seacure Advisors

Late Stage College Planning

June 5, 2018 By SeaCure Advisors Leave a Comment

“Help! My child is two years away from college and we haven’t saved much. What should we do?”

late state college planning

Your late start means you’ve missed most of the best opportunities to grow the money you have. With only two years until your child starts college, you’ll need to refine the college selection process, accumulate enough of a down payment for the early college bills, and establish a savings plan for the later college years. Here are some constructive steps you can take.

School search

First, help your child investigate schools that provide a good value. Some less expensive state universities and second-tier private colleges may offer better programs than their more expensive private counterparts. Think creatively. Your child could attend a nearby school and live at home for a year or two to save money on room and board. He or she could attend a community college for two years and then transfer to a private four-year college. Or, your child could consider cooperative education, where semesters of academic work alternate with semesters of paid work. If your finances are severely limited, your child might consider taking a year off before starting college.

Financial aid

Second, learn all you can about financial aid. Do a dry run through the federal government’s financial aid application to determine whether your child is likely to qualify for financial aid, and, if so, for how much. When you’ve zeroed in on a few colleges, examine their financial aid statistics. For example, what percentage of students receive financial aid? What percentage of the average package consists of loans? What percentage of a student’s financial need is generally met — 100%? 75%? Does the college offer merit scholarships? Use a net price calculator on a college’s website to get an idea of how much grant or scholarship aid your child might receive at a particular college based on your financial information.

Private Scholarships

Third, start investigating potential scholarships. There are a number of websites where your child can type in his or her interests, abilities, and goals to obtain a list of relevant scholarships. FastWeb is free and excellent.

However, outside scholarships generally make up only a small portion of a student’s overall aid package, and the process can be very competitive. So don’t make the mistake of thinking that a private scholarship will magically cover most of your child’s college expenses. It’s important that this search be made in addition to, not in place of, the quest for federal and college-sponsored financial aid.

Savings and Investments

Fourth, examine any current financial resources that you can draw on for the early college bills. Do you have savings accounts, stocks, mutual funds, or cash value life insurance? Can you pay a portion of the tuition bills from current income? Can you increase the family income by getting a second job or having a previously stay-at-home spouse return to the work force? If you’re still short, you’ll need to investigate a personal loan, home equity loan, or federal Parent PLUS Loan. In other cases, you may need to tap your retirement accounts, though this is generally recommended only as a last resort.

Cash Flow

Finally, you’ll need to start earmarking as much of your current income as you can for college bills that will come due in four or five years, when your child is a junior or senior in college. Because you’ll need the money relatively soon, you should avoid high-risk investments. Instead, choose a low-risk, stable investment, such as a certificate of deposit that is timed to mature when you need it, or a money market mutual fund.

Have A Plan

This process is complex and timing is critical. Often, families don’t have the bandwidth or resources by themselves to do the work necessary to ensure their college plan is right for them. If this sounds familiar, you aren’t alone. Many families with high school sophomores, juniors, and seniors are in the same situation. Help is available.

Speak to a college financial planner who has specific experience in the college planning space and have them review your plan and options. You can book a complementary personal consultation with SeaCure here.

Investing For Major Life Goals

May 22, 2018 By SeaCure Advisors Leave a Comment

Go out into your yard and dig a big hole. Every month, throw $50 into it, but don’t take any money out until you’re ready to buy a house, send your child to college, or retire. It sounds a little crazy, doesn’t it? But that’s what investing without setting clear-cut goals is like. If you’re lucky, you may end up with enough money to meet your needs, but you have no way to know for sure.

How do you set goals?

The first step in investing is defining your dreams for the future. If you are married or in a long-term relationship, spend some time together discussing your joint and individual goals. It’s best to be as specific as possible. For instance, you may know you want to retire, but when? If you want to send your child to college, does that mean an Ivy League school or the community college down the street?

You’ll end up with a list of goals. Some of these goals will be long term (you have more than 15 years to plan), some will be short term (5 years or less to plan), and some will be intermediate (between 5 and 15 years to plan). You can then decide how much money you’ll need to accumulate and which investments can best help you meet your goals. Remember that there can be no guarantee that any investment strategy will be successful and that all investing involves risk, including the possible loss of principal.

Looking forward to retirement

After a hard day at the office, do you ask, “Is it time to retire yet?” Retirement may seem a long way off, but it’s never too early to start planning — especially if you want your retirement to be a secure one. The sooner you start, the more ability you have to let time do some of the work of making your money grow.

Let’s say that your goal is to retire at age 65 with $500,000 in your retirement fund. At age 25 you decide to begin contributing $250 per month to your company’s 401(k) plan. If your investment earns 6 percent per year, compounded monthly, you would have more than $500,000 in your 401(k) account when you retire. (This is a hypothetical example, of course, and does not represent the results of any specific investment.)

But what would happen if you left things to chance instead? Let’s say you wait until you’re 35 to begin investing. Assuming you contributed the same amount to your 401(k) and the rate of return on your investment dollars was the same, you would end up with only about half the amount in the first example. Though it’s never too late to start working toward your goals, as you can see, early decisions can have enormous consequences later on.

Some other points to keep in mind as you’re planning your retirement saving and investing strategy:

Plan for a long life. Average life expectancies in this country have been increasing for years and many people live even longer than those averages.
Think about how much time you have until retirement, then invest accordingly. For instance, if retirement is a long way off and you can handle some risk, you might choose to put a larger percentage of your money in stock (equity) investments that, though more volatile, offer a higher potential for long-term return than do more conservative investments. Conversely, if you’re nearing retirement, a greater portion of your nest egg might be devoted to investments focused on income and preservation of your capital.
Consider how inflation will affect your retirement savings. When determining how much you’ll need to save for retirement, don’t forget that the higher the cost of living, the lower your real rate of return on your investment dollars.

Facing the truth about college savings

Whether you’re saving for a child’s education or planning to return to school yourself, paying tuition costs definitely requires forethought — and the sooner the better. With college costs typically rising faster than the rate of inflation, getting an early start and understanding how to use tax advantages and investment strategy to make the most of your savings can make an enormous difference in reducing or eliminating any post-graduation debt burden. The more time you have before you need the money, the more you’re able to take advantage of compounding to build a substantial college fund. With a longer investment time frame and a tolerance for some risk, you might also be willing to put some of your money into investments that offer the potential for growth.

Consider these tips as well:

Estimate how much it will cost to send your child to college and plan accordingly. Estimates of the average future cost of tuition at two-year and four-year public and private colleges and universities are widely available.
Research financial aid packages that can help offset part of the cost of college. Although there’s no guarantee your child will receive financial aid, at least you’ll know what kind of help is available should you need it.
Look into state-sponsored tuition plans that put your money into investments tailored to your financial needs and time frame. For instance, most of your dollars may be allocated to growth investments initially; later, as your child approaches college, more conservative investments can help conserve principal.
Think about how you might resolve conflicts between goals. For instance, if you need to save for your child’s education and your own retirement at the same time, how will you do it?

Investing for something big

At some point, you’ll probably want to buy a home, a car, maybe even that yacht that you’ve always wanted. Although they’re hardly impulse items, large purchases often have a shorter time frame than other financial goals; one to five years is common.

Because you don’t have much time to invest, you’ll have to budget your investment dollars wisely. Rather than choosing growth investments, you may want to put your money into less volatile, highly liquid investments that have some potential for growth, but that offer you quick and easy access to your money should you need it.

The Main Differences Between Federal and Private Student Loans

May 14, 2018 By SeaCure Advisors Leave a Comment

The following article about student loans was written by Jeff Gitlen and published on LendEdu on May 3, 2018. It is being presented here with permission from Andrew Rombach.

Figuring out how you’re going to pay for college? Congratulations – making it to this point is an accomplishment in and of itself. The fact that you are getting prepared for the financial questions of higher education means that you’re serious about your future.

Unfortunately, most of you will get hit with a massive reality check when you look at how much your preferred schools will cost us. If your family savings isn’t enough to cover four years of tuition, then you are most likely going to resort to some sort of financial aid.

For many students, savings, grants and scholarships don’t cover the full cost, so they need to turn to student loans in order to pay for college.

In general, there are two main types of loans that a student borrower has available to them.

The simplest federal student loans definition is a loan that is funded by the government and comes with more borrower-friendly terms and options. The basic private student loans definition is a loan that is funded by private lenders and typically comes with harsher terms.

Federal vs. Private Student Loans: The Different Types of Loans

Some of the first differences between federal student loans and private student loans become apparent when you look at the different offers available to borrowers. The federal government outlines multiple different loans for specific borrowers, while the private sector breaks it down differently. Either way, there are multiple sub-types of student loans within each category that borrowers need to carefully consider.

Types of Federal Student Loans

Direct Subsidized Stafford Loans

These loans are considered to have the friendliest terms to students. Only borrowers who fall under a certain financial need threshold can receive them. These are subsidized because the government pays off the interest during school until repayment starts. Here are a few more details:

Only available to undergraduate students
Eligibility and size of loan is based on financial need
Students pay no interest while they’re enrolled at least half-time or during the six-month deferment period after graduation. After, they must pay interest.

Direct Unsubsidized Stafford Loans

These are similar to the previous Stafford loan, but they are unsubsidized. These are more widely available to more students without the same financial need threshold, but the government doesn’t cover the interest payments before the repayment period. Here are more details:

Available to both undergraduate and graduate students
No financial need requirement
Students are on the hook for interest payments from start to finish. While they can choose to start paying interest until after the grace period, all interest is added to the principal balance at the start of repayment.

Direct PLUS Loans

Direct PLUS Loans are offered to the parents of undergraduate students or to graduate/professional students. A student’s parent or graduate student can take out as much as necessary to cover the cost of attendance. They are the only federal student loan program that takes into account applicant credit history.

Undergraduate students’ parents are eligible, as well as graduate or professional students
Loan limit based on cost of attendance
Must not have bad credit to be eligible

Perkins Loans

The Perkins loan program was discontinued at the end of September 2017, so they are no longer available. They are included in this list because there may still be borrowers with outstanding Perkins student loan debt. With the Perkins Loans program, the school itself is the lender, and low interest loans are offered to borrowers under a certain financial need threshold. Here are a few more details:

Payments made to the school or school’s servicer
Exceptional financial need has to be demonstrated
Program discontinued as of September 2017

Types of Private Student Loans

Private student loans cannot be broken down the same way as federal loans. There aren’t clearly defined programs from one source: the federal government. Instead, there are a wide range of options that are available through various different lenders and banks.

There are a few common denominators. First, they are not funded by the government which is obvious. Second, private student loan applications are subject to similar standards of approval as a typical credit application. This means that approval-decline decisions as well as the loan terms are based on an applicant’s (or a cosigner’s) credit history.

While federal loans can be broken down by program, private student loans are not so clear cut. Here’s a basic overview of what the private sector offers. At a high level, there are standard student loan options for undergraduate and graduate students. Additionally, some lenders do offer specialized graduate loans. You can find graduate loans meant specifically for students entering pre-med, law school, or other professions.

Qualifying for a Federal Loan vs. a Private Loan

Federal Student Loans

Applicants are approved after filing the Free Application for Federal Student Aid (FAFSA); there is no other application.
Loan offers are based on family income, expected contributions, and financial need.
The only time credit history matters would be if you are applying for a Direct PLUS Loan.
No cosigner is needed.

Private Student Loans

Lenders have their own loan applications as well as eligibility criteria.
Loan offers are based on credit history and income in most cases.
Other factors such as employment, school, or major may factor into your eligibility in some cases.
Unqualified borrowers may need a cosigner which are accepted on applications.

Applying for a Student Loan

Applying for Private Student Loans

In order to apply for a private student loan, the process really varies depending on which private lender you’re considering. Each bank, for example, has its own student loan application process. It typically involves an online application, a credit check, and other documents and information may be requested.

As mentioned earlier, you have the option of adding a cosigner to your loan application which may bolster your case for a private student loan. At any rate, you should check each individual private lender’s website to find out what their application process entails.

Applying for Federal Student Loans

For federal student loans, you must complete the FAFSA each year; it is necessary to be eligible for any federal financial aid for higher education. The application opens annually on October 1 and remains open for over a year afterwards. For the 2018-2019 school year, the window of completion is from October 1, 2018 to June 30, 2019.

It’s generally best to get the FAFSA done as early as possible. First, you want to avoid missing deadlines. Second, some programs have limited funding and require an early application (meaning don’t wait because it could be gone). Also, your school will most likely use your FAFSA results to determine your financial aid package – which is generally sent out to students in late winter or early spring.

The government will let you know what sort of financial aid, including student loans, you will be eligible for.

The Costs of Borrowing

Private Student Loan Rates

Private student loan interest rates are set by the lenders themselves, but they are all based on the market rate set by the US Treasury, the benchmark for loan products in the United States.

Looking at the industry as a whole, private student loan rates can range anywhere from as low as roughly 3.6 percent to as high as about 13 percent (maybe even higher depending on the lender). Keep in mind that the range of rates will vary by lender, and rates in general are always subject to change at a lender’s discretion.

While there is a rough range of possible rates outlined above, individual borrowers will know more about their interest rate during or after the application process. As mentioned previously, loan terms, including interest rates, are dependent on credit history and other criteria. In general, a creditworthy borrower may expect a rate closer to the low end, while a less creditworthy borrower may expect a rate closer to the high end.

Contrary to federal loans, private lenders usually offer both variable or fixed rates on their student loans, and these can have an impact on the cost of your loan. Variable-rate loans are typically offered at a lower APR. Additionally, these rates are subject to change with the market, so they could end up rising or falling over time. The other option is a fixed-rate loan. These are usually offered at higher APRs relative to variable-rate loans, but they do not fluctuate with the market after the loan is disbursed.

Federal Student Loan Interest Rates

Federal student loan interest rates are also based on the market rate, but they are set by the Federal government each year. Contrary to private loans, they are fixed-rate loans, so there is no fluctuation in APR during repayment. Since federal loans are broken out simply by program, it’s much easier to break down the interest rates. Here is a list of the current federal rates for loans taken out after July 1, 2017:

Direct Subsidized Undergraduate Loans: 4.45%
Direct Unsubsidized Undergraduate Loans: 4.45%
Direct Unsubsidized Graduate/Professional Loans: 6%
Direct PLUS Loans: 7%
Perkins: 5% (discontinued)

Origination Fees and Prepayment Penalties

Origination Fees

Federal student loans some with several different origination fees. Direct subsidized and unsubsidized student loans come with a 1.066 percent loan fee on loans disbursed between October 2017 and October 2018. Direct PLUS loans come with a fee of 4.264 percent if disbursed over the same time period.

Many private lenders advertise no origination fee. However, there are still some lenders that charge the fee as a percentage of the loan amount.

Prepayment Penalty Fees

There are no prepayment fees associated with federal student loans. Also, there are many private lenders who do not charge origination fees. However, there are still some lenders that do, but these will vary on a case-by-case basis.

Student Loan Repayment Options

Federal student loan repayment options are much more flexible compared to private student loans. In a broad overview, there are four category repayment plans.

The ten-year Standard Repayment Plan is the first default option; it involves 120 installment payments over ten years. The Graduated Repayment Plan is another option. Graduated repayment involves 120 payments over ten years, but payments start low and gradually increase over time. The Extended Repayment Plan entails 300 installment payments over 25 years, and the borrower can choose a standard or graduated repayment schedule.

Finally, there are four different income-driven repayment (IDR) plans: income-based repayment (IBR), income-contingent repayment (ICR), income-sensitive repayment, Pay As You Earn Repayment (PAYE), and Revised Pay As You Earn Repayment (REPAYE). All of these plans base monthly payments off of discretionary income, and repayment terms vary from 15 to 25 years. If eligible, some borrowers can have their remaining balances forgiven after the repayment term is up.

Private student loan repayment options are nowhere near as flexible. The industry standard is the ten-year repayment plan – 120 installment payments over ten years. Throughout the industry, student borrowers can find lenders offering repayment terms from five to 15 years.

Federal vs. Private Student Loans: Which is Better?

Federal student loans are the clear winner here – they are available, have interest rates that are better geared to college students who are new to credit, a six-month grace period and deferment options, flexible repayment options, and other benefits and protections.

Private student loans can be reasonably priced, but they will generally come with a double-digit interest rates for new-to-credit borrowers. You or a cosigner must have a strong credit history to be considered, and there are fewer protections and benefits.

Try to get federal student loans first, then only turn to private sector lenders as a last resort to cover any remaining expenses.

NOTE: The following disclaimer appears on the LendEdu website above this article:

Our research, news, and assessments are scrutinized using strict editorial integrity. In full transparency, our company may receive compensation from partners listed on our website. Learn more about how we make money here.

Changing Market: Municipal Bonds After Tax Reform

May 8, 2018 By SeaCure Advisors Leave a Comment

January is typically a strong month for the municipal bond market, but 2018 began with the worst January performance since 1981, driven by rising interest rates and uncertainty over changes in the Tax Cuts and Jobs Act (TCJA).¹ The muni market stabilized through April 2018, but uncertainty remains.² The tax law changed the playing field for these investments, which could affect supply and demand.

When considering these dynamics, keep in mind that bond prices and yields have an inverse relationship, so increased demand generally drives bond prices higher and yields lower, and vice versa. Any such changes directly affect the secondary market for bonds and might also influence new-issue bonds. If you hold bonds to maturity, you should receive the principal and interest unless the bond issuer defaults.

Tax rates and deduction limits

Municipal bonds are issued by state and local governments to help fund ongoing expenses and finance public projects such as roads, water systems, schools, and stadiums. The primary appeal of these bonds is that the interest is generally exempt from federal income tax, as well as from state and local taxes if you live in the state where the bond was issued. Because of this tax advantage, a muni with a lower yield might offer greater value than a taxable bond with a higher yield, especially for investors in higher tax brackets.

The lower federal income tax rates established by the new tax law would cut into this added value, but the difference is relatively small and unlikely to affect demand. Many taxpayers, especially in high-tax states, may find munis even more appealing to help replace deductions lost to other TCJA provisions, including the $10,000 cap for deductions of state and local taxes.³ Tax-free muni interest can help lower taxable income regardless of whether you itemize deductions.

The large corporate tax reduction from a top rate of 35% to 21% is likely to have a more significant effect on demand for munis. Corporations, which own a little less than 30% of the muni market, may hold on to bonds they currently own but become more selective in purchasing future bonds.⁴

Municipal bond yields

Federal Income Tax Rate	Taxable Equivalent Yield on 3% Muni
22%	3.85%
24%	3.94%
32%	4.41%
35%	4.62%
37%	4.76%

A tightening market

The supply of new municipal bonds dropped after the fiscal crisis as local governments became more cautious about borrowing. The TCJA further tightened the market by eliminating “advanced refunding” bonds, issued to replace older bonds at lower interest rates, which have accounted for about 15% of new issues.⁵

This is expected to reduce the supply of bonds for the next three years or so, but the long-term effects are unclear. If interest rates continue to climb, there is less to gain by replacing older bonds, but local governments may issue taxable bonds if they see an opportunity to reduce interest payments. There may also be changes to the structure of future muni issues.⁶

Risk and rising interest rates

Munis are considered less risky than corporate bonds and less sensitive to changing interest rates than Treasuries, making them an appealing middle ground for many investors. For the period 2007 to 2016, which includes the recession, the five-year default rate for municipal bonds was 0.15%, compared with 6.92% for corporate bonds. Most of those defaults were related to severe fiscal situations such as those in Detroit and Puerto Rico. The five-year default rate for investment-grade bonds (rated AAA to BBB/Baa) was just 0.05%.⁷

Treasuries, which are backed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, are considered the most stable fixed-income investment, and rising Treasury yields, as occurred in early 2018, tend to put downward pressure on munis.⁸ However, Treasuries are more sensitive to interest rate changes, and stock market volatility makes both Treasuries and munis appealing to investors looking for stability.

Bond funds

The most convenient way to add municipal bonds to your portfolio is through mutual funds, which also provide diversification that can be difficult to create with individual bonds. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

Muni funds focused on a single state offer the added value of tax deductibility for residents of those states, but smaller state funds may not offer the level of diversification found in larger states. It’s also important to consider the holdings and credit risks of any bond fund, including those dedicated to a specific state. For example, in October 2017, many state funds still held Puerto Rico bonds, which are generally exempt from state income tax but carry high credit risk.⁹

If a bond was issued by a municipality outside the state in which you reside, the interest may be subject to state and local income taxes. If you sell a municipal bond at a profit, you could incur capital gains taxes. Some municipal bond interest may be subject to the alternative minimum tax.

The return and principal value of bonds and bond fund shares fluctuate with changes in market conditions. When redeemed, they may be worth more or less than their original cost. Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund’s performance. Investments offering the potential for higher rates of return involve a higher degree of risk.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1, 8) CNBC, February 28, 2018

2) Bloomberg, 2018 (Bloomberg Barclays U.S. Municipal Index for the period 1/1/2018 to 4/16/2018)

3-4, 6) The Bond Buyer, February 12, 2018

5) The New York Times, February 23, 2018

7) Moody’s Investors Service, 2017

9) CNBC, October 10, 2017

Save For College With Tax Advantages

April 18, 2018 By SeaCure Advisors Leave a Comment

The best college savings vehicles offer special tax advantages if the funds are used to pay for college. Tax-advantaged strategies are important because over time, you can potentially accumulate more money with a tax-advantaged investment compared to a taxable investment. Ideally, though, you’ll want to choose a savings vehicle that offers you the best combination of tax advantages, financial aid benefits, and flexibility, while meeting your overall investment needs.

529 plans

Since their creation in 1996, 529 plans have become to college savings what 401(k) plans are to retirement savings — an indispensable tool for saving money for a child’s or grandchild’s college education. That’s because 529 plans offer a unique combination of benefits.

There are two types of 529 plans — savings plans and prepaid tuition plans. Though each is governed under Section 529 of the Internal Revenue Code (hence the name “529” plans), savings plans and prepaid tuition plans are very different savings vehicles.

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing; specific plan information is available in each issuer’s official statement. There is the risk that investments may not perform well enough to cover college costs as anticipated. Also, before investing, consider whether your state offers any favorable state tax benefits for 529 plan participation, and whether these benefits are contingent on joining the in-state 529 plan. Other state benefits may include financial aid, scholarship funds, and protection from creditors.

529 savings plans

The more popular type of 529 plan is the savings plan. A 529 savings plan is a tax-advantaged savings vehicle that lets you save money for college and K-12 tuition in an individual investment-type account, similar to a 401(k) plan. Some plans let you enroll directly, while others require you to go through a financial professional.

The details of 529 savings plans vary by state, but the basics are the same. You’ll need to fill out an application, name a beneficiary, and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be made in cash.

529 savings plans offer a unique combination of features that no other education savings vehicle can match:

Federal tax advantages: Contributions to a 529 account accumulate tax deferred and earnings are tax free if the money is used to pay the beneficiary’s qualified education expenses. (The earnings portion of any withdrawal not used for qualified education expenses is taxed at the recipient’s rate and subject to a 10% penalty.)

State tax advantages: Many states offer income tax incentives for state residents, such as a tax deduction for contributions or a tax exemption for qualified withdrawals. However, be aware that some states limit their tax deduction to contributions made to the in-state 529 plan only.

High contribution limits: Most plans have lifetime contribution limits of $350,000 and up (limits vary by state).

Unlimited participation: Anyone can open a 529 savings plan account, regardless of income level.

Wide use of funds: Money in a 529 savings plan can be used to pay the full cost (tuition, fees, room and board, books) at any college or graduate school in the United States or abroad that is accredited by the Department of Education, and for K-12 tuition expenses up to $10,000 per year.

Professional money management: 529 savings plans are offered by states, but they are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.

Flexibility: Under federal rules, you are entitled to change the beneficiary of your account to a qualified family member at any time as well as roll over (transfer) the money in your account to a different 529 plan once per calendar year without income tax or penalty implications.

Accelerated gifting: 529 savings plans offer an estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s education while paring down their own estate, or a way for parents to contribute a large lump sum. Under special rules unique to 529 plans, a lump-sum gift of up to five times the annual gift tax exclusion amount ($15,000 in 2018) is allowed in a single year, which means that individuals can make a lump-sum gift of up to $75,000 and married couples can gift up to $150,000. No gift tax will be owed, provided the gift is treated as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.

Transfer to ABLE account: 529 account owners can roll over (transfer) funds from a 529 account to an ABLE account without federal tax consequences. An ABLE account is a tax-advantaged account that can be used to save for disability-related expenses for individuals who become blind or disabled before age 26.

Variety: Currently, there are over 50 different savings plans to choose from because many states offer more than one plan. You can join any state’s savings plan.

But 529 savings plans have a couple of drawbacks:

No guaranteed rate of return: Investment returns aren’t guaranteed. You roll the dice with the investment portfolios you’ve chosen, and your account may gain or lose value depending on how the underlying investments perform. There is no guarantee that your investments will perform well enough to cover college costs as anticipated.

Investment flexibility: 529 savings plans have limited investment flexibility. Not only are you limited to the investment portfolios offered by the particular 529 plan, but once you choose your investments, you can only change the investment options on your existing contributions twice per calendar year. (However, you can generally direct how your future contributions will be invested at any time.)

529 prepaid tuition plans

Prepaid tuition plans are cousins to savings plans – their federal tax treatment is the same, but their operation is very different. A 529 prepaid tuition plan lets you prepay tuition at participating colleges, typically in-state public colleges, at today’s prices for use by the beneficiary in the future. Prepaid tuition plans are generally limited to state residents, whereas 529 savings plans are open to residents of any state. Prepaid tuition plans can be run either by states or colleges, though state-run plans are more common.

As with 529 savings plans, you’ll need to fill out an application and name a beneficiary. But instead of choosing an investment portfolio, you purchase an amount of tuition credits or units, subject to plan rules and limits. Typically, the tuition credits or units are guaranteed to be worth a certain amount of college tuition in the future, no matter how much college costs may increase between now and then.

However, if your child ends up attending a college that doesn’t participate in the plan, prepaid plans differ on how much money you’ll get back. Also, some prepaid plans have been forced to reduce benefits after enrollment due to investment returns that have not kept pace with the plan’s offered benefits.

Even with these limitations, some college investors appreciate not having to worry about college inflation each year and want to lock in college tuition prices today. The following table summarizes the main differences between 529 savings plans and 529 prepaid tuition plans:

529 savings plans	529 prepaid tuition plans
Offered by states	Offered by states and private colleges
You can join any state’s plan (though some plans may require you to enroll with a financial professional)	State-run plans require you to be a state resident
Contributions are invested in your individual account in the investment portfolios you have selected	Contributions are pooled with the contributions of others and invested by the plan
Returns are not guaranteed; your account may gain or lose value depending on how the underlying investments perform.	Generally a certain rate of return is guaranteed in the form of a percentage of tuition being covered in the future, no matter how much costs may increase by then
Funds can generally be used for the full cost of tuition, fees, room and board, equipment and books at any accredited college or graduate school in the U.S. or abroad, or K-12 tuition expenses up to $10,000 per year	Funds can be used only for tuition at participating colleges (typically state colleges); room and board and graduate school generally are not eligible expenses

Coverdell education savings accounts

A Coverdell education savings account (Coverdell ESA) is a tax-advantaged education savings vehicle that lets you save money for college, as well as for elementary and secondary school (K-12) at public, private, or religious schools. Here’s how it works:

Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account. The beneficiary must be under age 18 when the account is established (unless he or she is a child with special needs).
Contribution rules: You (or someone else) make contributions to the account, subject to the maximum annual limit of $2,000. This means that the total amount contributed for a particular beneficiary in a given year can’t exceed $2,000, even if the money comes from different people. Contributions can be made up until April 15 of the year following the tax year for which the contribution is being made.
Investing contributions: You invest your contributions as you wish (e.g., stocks, bonds, mutual funds, certificates of deposit)–you have sole control over your investments.
Tax treatment: Contributions to your account grow tax deferred, which means you don’t pay income taxes on the account’s earnings (if any) each year. Money withdrawn to pay college or K-12 expenses (called a qualified withdrawal) is completely tax free at the federal level(and typically at the state level too). If the money isn’t used for college or K-12 expenses (called a nonqualified withdrawal), the earnings portion of the withdrawal will be taxed at the beneficiary’s tax rate and subject to a 10% federal penalty.
Rollovers and termination of account: Funds in a Coverdell ESA can be rolled over without penalty into another Coverdell ESA for a qualifying family member. Also, any funds remaining in a Coverdell ESA must be distributed to the beneficiary when he or she reaches age 30 (unless the beneficiary is a person with special needs).

Unfortunately, not everyone can open a Coverdell ESA–your ability to contribute depends on your income. To make a full contribution, single filers must have a modified adjusted gross income (MAGI) of less than $95,000, and joint filers must have a MAGI of less than $190,000. And with an annual maximum contribution limit of $2,000, a Coverdell ESA can’t go it alone in meeting today’s college costs.

Custodial accounts

Before 529 plans and Coverdell ESAs, there were custodial accounts. A custodial account allows your child to hold assets–under the watchful eye of a designated custodian–that he or she ordinarily wouldn’t be allowed to hold in his or her own name. The assets can then be used to pay for college or anything else that benefits your child (e.g., summer camp, braces, hockey lessons, a computer). Here’s how a custodial account works:

Application process: You fill out an application at a participating financial institution and name a beneficiary. Depending on the institution, there may be fees associated with opening and maintaining the account.
Custodian: You also designate a custodian to manage and invest the account’s assets. The custodian can be you, a friend, a relative, or a financial institution. The assets in the account are controlled by the custodian.
Assets: You (or someone else) contribute assets to the account. The type of assets you can contribute depends on whether your state has enacted the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). Examples of assets typically contributed are stocks, bonds, mutual funds, and real property.
Tax treatment: Earnings, interest, and capital gains generated from assets in the account are taxed every year to the child under special “kiddie tax” rules that apply when a child has unearned income. The kiddie tax rules generally apply to children under age 18 and full-time college students under age 24 whose earned income doesn’t exceed one-half of their support. Under the kiddie tax rules, a child’s unearned income is taxed using the trust and estate tax rates.

A custodial account provides the opportunity for some tax savings, but the kiddie tax reduces the overall effectiveness of custodial accounts as a tax-advantaged college savings strategy. And there are other drawbacks. All gifts to a custodial account are irrevocable. Also, when your child reaches the age of majority (as defined by state law, typically 18 or 21), the account terminates and your child gains full control of all the assets in the account. Some children may not be able to handle this responsibility, or might decide not to spend the money for college.

U.S. savings bonds

Series EE and Series I bonds are types of savings bonds issued by the federal government that offer a special tax benefit for college savers. The bonds can be easily purchased from most neighborhood banks and savings institutions, or directly from the federal government. They are available in face values ranging from $50 to $10,000. You may purchase the bond in electronic form at face value or in paper form at half its face value.

If the bond is used to pay qualified education expenses and you meet income limits (as well as a few other minor requirements), the bond’s earnings are exempt from federal income tax. The bond’s earnings are always exempt from state and local tax.

In 2018, to be able to exclude all of the bond interest from federal income tax, married couples must have a modified adjusted gross income of $119,300 or less at the time the bonds are redeemed (cashed in), and individuals must have an income of $79,550 or less. A partial exemption of interest is allowed for people with incomes slightly above these levels.

The bonds are backed by the full faith and credit of the federal government, so they are a relatively safe investment. They offer a modest yield, and Series I bonds offer an added measure of protection against inflation by paying you both a fixed interest rate for the life of the bond (like a Series EE bond) and a variable interest rate that’s adjusted twice a year for inflation. However, there is a limit on the amount of bonds you can buy in one year, as well as a minimum waiting period before you can redeem the bonds, with a penalty for early redemption.

Roth IRAs

Though technically not a college savings account, some parents use Roth IRAs to save and pay for college. In 2018, you can contribute up to $5,500 per year. Earnings in a Roth IRA accumulate tax deferred. Contributions to a Roth IRA can be withdrawn at any time and are always tax free. For parents age 59½ and older, a withdrawal of earnings is also tax free if the account has been open for at least five years. For parents younger than 59½, a withdrawal of earnings–typically subject to income tax and a 10% premature distribution penalty–is spared the 10% penalty if the withdrawal is used to pay for a child’s college expenses.

But not everyone is eligible to contribute to a Roth IRA–it depends on your income. In 2018, if your filing status is single or head of household, you can contribute the full $5,500 to a Roth IRA if your MAGI is $120,000 or less. And if you’re married and filing a joint return, you can contribute the full $5,500 if your MAGI is $189,000 or less.

Financial aid impact

Your college saving decisions can impact the financial aid process. Come financial aid time, your family’s income and assets are run through a formula at both the federal level and the college (institutional) level to determine how much money your family should be expected to contribute to college costs before you receive any financial aid. This number is referred to as your expected family contribution, or EFC. Your income is by far the most important factor, but your assets count too.

In the federal calculation, your child’s assets are treated differently than your assets. Your child must contribute 20% of his or her assets each year, while you must contribute 5.6% of your assets. For example, $10,000 in your child’s bank account would equal an expected contribution of $2,000 from your child ($10,000 x 0.20), but the same $10,000 in your bank account would equal an expected $560 contribution from you ($10,000 x 0.056).

Under the federal rules, an UTMA/UGMA custodial account is classified as a student asset. By contrast, 529 plans and Coverdell ESAs are counted as parent assets if the parent is the account owner. In addition, student-owned or UTMA/UGMA-owned 529 accounts are also counted as parent assets. For 529 plans and Coverdell accounts that are counted as parent assets, distributions (withdrawals) from the account that are used to pay the beneficiary’s qualified education expenses are not counted as parent or student income on the federal government’s aid form, which means that the money is not counted again when it’s withdrawn.

However, the situation is different for grandparent-owned 529 plans and Coverdell accounts. If a 529 plan or Coverdell account is owned by a grandparent instead of a parent, the account isn’t counted as a parent asset–it doesn’t count as an asset at all. However, money withdrawn from a grandparent-owned account is counted as student income, and student income is assessed at 50% in the federal aid formula.

Other investments parents may own in their name, such as mutual funds, stocks, U.S. savings bonds, certificates of deposit, and real estate, are also classified as parent assets. However, the federal government doesn’t count retirement assets at all in its financial aid formula, so Roth IRAs aren’t factored in to aid eligibility.

Regarding institutional aid, colleges generally dig a bit deeper than the federal government in assessing a family’s assets and their ability to pay college costs. Most colleges use a standard financial aid application that considers assets the federal government might not, for example, home equity. Typically, though, colleges treat 529 plans, Coverdell accounts, UTMA/UGMA custodial accounts, U.S. savings bonds, and Roth IRAs the same as the federal government.