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How Advisers can Help Clients Build College Funds

It's important that parents saving for their children's college education not short-change their own retirement savings.

Saving for their children’s education is a priority for many parents. Financial advisers can provide particular expertise in helping their clients strategize ways to save for their children’s education while not taking their focus off saving for retirement.

Parents want the best for their children and in some cases divert money that should be going towards saving for their retirement to saving for their children’s education. There are no retirement do-overs and advisers should stress to their clients the importance of managing these priorities.

There are a number of ways to pay for college and their children will thank them for funding their retirement and not needing their financial help down the road.

529 Plans

These are tax-advantaged accounts where parents can deposit after-tax dollars to save for a child’s education. Each child is considered a beneficiary and needs a separate account. If the money is used to cover higher education expenses such as tuition, books, housing and a host of other qualified costs, the money comes out tax-free. Money used for non-qualified expenses would be subject to taxes and a 10% penalty.

In some cases, there can be tax advantages at the state level for using the client’s home state plan. Many 529s are offered by major firms like T. Rowe Price and Vanguard. They generally offer a menu of mutual fund-like accounts as well as age-based options that act much like target-date funds. There are generally restrictions as to how often the investment options can be changed.

The tax reform act of 2017 allowed 529s to be used for education for elementary and high school costs, but the proceeds may be subject to taxes or penalties at the state level.

If all of the funds are not used by the beneficiary, or if this child doesn’t attend college or some other post-high school educational institution, the funds can be directed toward another child. Additionally, contributions can be made by others besides the parents. Grandparents can contribute for example.

UGMA or UTMA Accounts

UGMA and UTMA accounts are custodial accounts. UGMA stands for Uniform Gift to Minors Act and UTMA stands for Uniform Transfer to Minors Act. Both are custodial accounts that allow for the transfer of assets to minors under 18 and both offer certain tax benefits, generally taking advantage of the child’s lower tax rate.

The downsides are that once the money is transferred to the child, there are few if any restrictions as to how they use it if they decide not to attend college or pursue other post-high school training. The transfer to the child is irrevocable. Additionally, this money could hinder their ability to qualify for financial aid based on how it is counted on the all-important Free Application for Federal Student Aid (FAFSA) form.

Roth IRAs

Roth IRAs are generally not thought of as college savings accounts, but withdrawals can be taken from Roth accounts penalty-free to cover qualified higher educational expenses, though any earnings that are withdrawn from the account would be subject to taxes. Contributions can always be withdrawn tax and penalty-free.

College savings is not the most ideal use for a Roth IRA, but this can be a component in your client’s college savings efforts, especially if they come up a bit short in a particular year. Additionally, the knowledge that they can access the money penalty-free can help them be comfortable making Roth contributions if their income qualifies.

Prepaid Tuition Plans

Some states offer prepaid tuition plans that lock in today’s current tuition rates. This can be a good option if your client is certain that their child will attend a qualifying in-state public university.

If their preferences change, there may be options to still utilize the money to cover part of the costs at other institutions, but it can leave the client short if they were not prepared for this possibility.

Additionally, several of the pre-paid plans ran into financial difficulties in the wake of the financial crisis and were not able to meet all of their obligations. Currently only a few states offer these plans.


An educational trust can be used to accumulate funds for a child’s education. The terms of the trust should be spelled out indicating what the money can and cannot be used for. Using a trust can be beneficial for parents and grandparents wishing to transfer assets out of their estate to tax reasons.

The rules of the client’s state need to be considered. Additionally any potential taxes to the grantor or the beneficiary must be considered in structuring the trust.

Taxable Investments

While various types of college savings accounts get a lot of publicity, there is nothing wrong with plain-old taxable investments to help fund college savings for your client’s children. This might be in the form of regular automatic savings into several mutual funds or earmarking a portion of the client’s taxable account for college. While this isn’t always the most tax-efficient method, it is easy and relatively hassle-free. Obviously capital gains taxes could come into play.

Have a Plan

Mostly your clients need to have a plan for college savings that is integrated into their overall financial plan. This should incorporate the client saving for their retirement and other goals with college savings being a part of the picture. The client might consider life insurance to fund any shortfalls in their children’s college fund in the event of their premature death.

You should also encourage your clients to get their kids involved in the process through work during their teen years. Even if their contribution is minimal, this can be a great lifetime financial lesson for them.