A Comprehensive Guide to Saving for College for Doctors and Other High-Income Professionals
A Comprehensive Guide to Saving for College
If you have kids or are planning on having kids, saving for their college education is likely high on your list of financial priorities. With college tuition inflation rates averaging 6% (3% higher than the rest of the economy), it’s no wonder we’re stressed out about how we will help pay for our kids’ education.
How much should you save?
The first question you may ask is how much you need to save?
The answer depends on what you’d like to fund for your kids. According to the college board, for the 2024 academic year, the average cost of public, in-state tuition and fees is around $11,260 per year. Add room and board, and you're looking at roughly $30,000 per year. If you're aiming for a private school, that number jumps to around $60,000 per year.
That means the total cost of a four-year degree at a public in-state school is approximately $120,000, while a private school could cost upwards of $240,000.
To add to the challenge, tuition costs are projected to rise by about 6% per year.
So how much you should save depends on your specific goals and family circumstances. A financial advisor can help you crunch the numbers based on your investment growth rate, your child’s college preferences, and other personal factors.
That said, always remember this important principle: prioritize your own retirement savings first. Your children can borrow for college, but you can’t borrow for retirement.
Where should you save?
Choosing where to save may be the more daunting question to young parents getting started.
The main factors to consider when choosing an option are:
Tax benefits: Are there any tax advantages that can help your money grow faster?
Impact on financial aid: Will this account reduce your child’s chances of receiving need-based financial aid?
When applying to college, the FAFSA is filled out so schools can determine how much financial aid to offer the student. This calculation will determine how many grants, scholarships, and work-study options they are offered. It also determines how many and what type of federal loans are offered. Subsidized Stafford loans are loans that don’t accrue interest while the student is in school and while they are in the 6 month grace period. Unsubsidized loans start accruing interest the day the loan is made, making them a lot more costly.
Several accounts can be used to save for college, but only a couple have no adjusted gross income limits, so the choice is relatively simple for doctor families. But, it’s also important to know which of these accounts are counted as parental assets for student aid eligibility and which are counted as student or beneficiary assets.
Parental assets are preferred as a smaller percentage (max 5.64%) is expected to contribute to the student’s education. Expected contribution for funds held as a beneficiary asset may be as high as 20%.
Thankfully, retirement accounts and cash-value life insurance are excluded in the FAFSA calculations for financial aid.
The name of the game is to keep the assets in the beneficiary or student’s name to a minimum so they can obtain the most financial aid.
In this blog post, we’ll walk you through the most popular college savings options, breaking down their advantages, disadvantages, and key features.
1. 529 Savings Plans
529 plans are one of the most popular and flexible ways to save for education expenses. Here’s why:
No AGI limits: There are no income limits to contribute to 529 Savings Plans, making them a popular vehicle for saving for college for doctors.
Tax Benefits: The growth on contributions is tax-deferred, and withdrawals for qualified education expenses are tax-free. Additionally, contributions may be state tax-deductible in some states.
Tax Cuts and Jobs Act 2018: Under TCJA, funds can now also be used for K-12 private, public, or religious schools, and there's a penalty-free rollover to a 529 ABLE account for disabled beneficiaries or to Roth IRA’s in the name of the beneficiary.
Investment Control: You direct the contributions and investments, but they carry market risk.
Student Aid Impact: Considered a parental asset, which is favorable when calculating student aid eligibility.
Gift Tax Treatment: Allows for accelerated contributions (5 year lump sum contributions) without incurring gift taxes (up to $85,000 for individuals or $170,000 for couples).
Flexibility: Unused funds can be rolled over into a Roth IRA, making it an adaptable tool for long-term financial planning.
2. Prepaid Tuition Plans
Prepaid tuition plans allow you to purchase future tuition at current rates + a plan specific premium. Here are the key features:
No AGI limits: There are no income limitations to enroll in these plans
Cost Control: By locking in today’s rates, you protect yourself from future tuition hikes.
Limitations: Most of these plans are state-sponsored and may have residency requirements. They also tend to be plan-specific regarding out-of-state or private university use. Careful study of each plan is necessary to understand the impact on future college plans.
Student Aid Impact: Like 529 plans, they are considered a parental asset, which is beneficial for student aid purposes.
3. 529A ABLE Plans
ABLE (Achieving a Better Life Experience) plans are designed for individuals with disabilities to save for education and other essential expenses:
Tax-Deferred Growth: The funds grow tax-free if used for qualified education, healthcare, job training, and other expenses.
Social Security Considerations: Contributions up to $18,000 per year won't affect Social Security Disability Income, and funds up to $100,000 won't stop Supplemental Security Income (SSI).
4. Coverdell Education Savings Accounts (ESA)
Coverdell ESAs are another tax-advantaged savings vehicle for education, but with more limitations:
AGI limits: This plan has income limits that most doctor families won’t meet. Contributions are fazed out at $95-100k single and $190-220k married.
Contribution Limits: You can contribute up to $2,000 per year, subject to income limits.
Age Restrictions: The account must be fully distributed by age 30, though you can roll it over to a new beneficiary.
Tax Credits: Distributions don't qualify for education tax credits, making this a less favorable option for those looking to take advantage of programs like the American Opportunity Credit (also has income limits).
5. UTMA/UGMA Custodial Accounts
The Uniform Transfers to Minors Act (UTMA) and Uniform Gift to Minors Act (UGMA) accounts allow you to transfer assets to your child:
Parental Control: The parent manages the account until the child reaches the age of majority (18 or 21 depending on the state).
Student Aid Impact: These accounts are considered the beneficiary’s asset, which can negatively impact student aid eligibility.
Tax Considerations: Limited tax advantages apply, with investment income potentially taxed at the child’s rate, but exceeding certain thresholds triggers taxation at the parent's rate. See table for details.
6. Brokerage Accounts
For families seeking the most flexibility in their education savings, a standard brokerage account is an option:
No AGI limits: There are no income limits to contribute to a brokerage account.
No Contribution Limits: Unlike other savings vehicles, there are no limits on contributions.
Tax Considerations: No tax advantages are offered, but gains can be controlled through your choice of investments.
Student Aid Impact: Assets are treated as parental assets, which is beneficial for student aid calculations.
7. Series EE or I Bonds
These government-issued bonds are a conservative investment option for education savings:
AGI Limits: This account has income limits that would disqualify most doctors. Tax benefits are fazed out at $96.8k-111k single, and $145-175.2k married filing jointly.
Tax Benefits: Interest is tax-free when used for qualifying education expenses, but subject to income limits.
Student Aid Impact: These are treated as parental assets, offering a favorable impact on student aid calculations.
8. 2503(c) Trusts
A 2503(c) trust is an irrevocable trust designed to provide for education expenses:
Beneficiary Asset: The funds are considered the beneficiary’s asset, which can adversely affect student aid eligibility.
Tax Impact: Income generated by the trust is subject to the kiddie tax, making it less tax-efficient than other options.
9. IRA’s
IRA early withdrawal penalty fees are waived if the withdrawal is used for qualifying educational expenses. However, withdrawals are still subject to income tax. I almost didn’t want to include this option in here as this really should be the very last resort, since student’s can borrow for their education, but we can’t borrow for our retirement.
Parental Asset: IRA’s are not counted in FAFSA calculations as they are not meant to be used for educational expenses.
Tax Impact: Penalty fees are waived but withdrawals are still subjec to income tax
Please take a look at this table that breaks down the abovementioned accounts in a flow chart.
Conclusion
Each of these college savings options has its own benefits and drawbacks. Most full-time doctor families will not qualify for Coverdell Educational savings accounts or the Series EE/I bond tax advantages, leaving 529’s, UTMA/UGMA, and brokerage accounts as the only viable options.
Funds in UTMA/UGMA are counted as beneficiary assets, making them less desirable, leaving 529’s as a good choice for most doctors.
Remember, 529 Savings Plans are offered by individual states but can be used across state lines. 529 prepaid tuition plans have many more restrictions and may be harder to use across state lines, so 529 savings plans offer the most flexibility. Also, even though 529 savings plans are offered by states, you can contribute to any state’s 529 plan without being a resident there, though state tax benefits may be impacted if investing out of state.
Practical Tips for Getting Started
Now that you’ve explored your savings options, here are some practical tips to help you get started:
Start early: Time is your greatest ally. The sooner you start saving, the more time your investments have to grow.
Automate contributions: Set up automatic transfers to make saving easier and more consistent.
Involve family: Encourage family members to contribute to your child’s college fund instead of giving physical gifts for birthdays or holidays.
Reassess regularly: Review your savings plan each year to ensure you’re on track and adjust as needed.
Consider multiple savings vehicles: Mix and match 529 plans with other options, such as brokerage accounts or ABLE accounts, for added flexibility.
Encourage your child to participate: Teach your child about saving and personal finance early on. They can also contribute through part-time work or apply for scholarships.
Saving for college can feel like a monumental task, but with the right strategies in place, it’s achievable. Whether you choose a 529 plan for its tax advantages, a brokerage account for more control, or a mix of savings vehicles, the key is to start early, automate contributions, and stay consistent. Every little bit helps, and the sooner you begin, the more time your savings have to grow.
Starting early and saving consistently is key, but remember to prioritize your retirement savings first. College can be funded through loans, scholarships, and grants, but you can’t borrow for retirement. Don’t hesitate to seek professional advice to ensure you’re on the right path.
By taking proactive steps now, you can help your child graduate with as little debt as possible and set them—and yourself—on the road to financial freedom.
Stay informed and stay frugal, y’all!
-Disha
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