This is the ninth in a series of posts made in preparation for a presentation I will be making for physicians in fellowship training at an upcoming ACCP meeting. For most physicians, you will have three major investments over your lifetime: your house, your retirement, and your children’s education. It this post, we’ll examine the options that you have to save for your children’s college education. Although it is not exactly retirement planning, it does impact your retirement plans since if you don’t prepare for college expenses now, you may find yourself either unable to contribute money into retirement when college expenses come due or even worse, you may find yourself having to takes loans or early withdrawal from your retirement account to pay for your children’s college expenses.
If you are a physician, I’ve got some good news and some bad news for you. The good news is that you are going to have a very good income. The bad news is that your kids are not going to be eligible for financial aid when they go to college because you make too much money. So, unlike most Americans who send their kids to college, you are probably going to have to pay the sticker price… and that price is high. This year, the cost of tuition, room & board, books, and fees for the Ohio State University (a public university) is $22,753 for an Ohio resident. My wife’s and one of my daughter’s alma mater, Notre Dame (a private university) is $65,093. And this doesn’t include the cost of transportation and personal expenses. For 4 years of college, that adds up to $91,012 for a public university and $260,372 for a private university.
Even scarier is the fact that the cost of going to college has been increasing at about 5% per year, in other words, twice the regular inflation rate. That means that if you have a child born today, then in 18 years, a public university is going to cost you $54,758 for the first year and $236,013 for the entire 4 years of college. If your newborn child goes to a private university 18 years from now, that freshman year will cost $156,654 and the entire 4 years will cost $675,199. If you have 4 kids, like I have, then you’ll end up spending more on their education than you will to buy your house, so you have to start saving early.
Fortunately, you have several ways to save for your children’s college education: regular investments, Coverdell educational savings accounts, uniform gifts to minors accounts, and 529 plans. Let’s look at the advantages and disadvantages of each.
Regular investments. This would mean putting money in stocks, bonds, or mutual funds in your name and then drawing the money out when you eventually pay college expenses. The only advantage of this is that the money is yours so if your child ends up getting a full-ride scholarship or not going to college, then you can use the money for whatever you want with no penalty since you did not use it for college expenses. The disadvantage is that you have to pay taxes on the earnings: regular income tax on interest income and capital gains tax on dividend and capital gains income.
Coverdell educational savings accounts (ESAs). These used to be known as education IRAs back when I was saving for my kids’ education. The contribution limit is $2,000 per year and the initial contribution is not tax deductible. The money grows tax-free and if the investment is eventually used for education purposes, it is not taxed when it is withdrawn. You can put almost any kind of investment of your choosing including stocks, bonds, and mutual funds in the ESA. An important limitation is that If your taxable income is greater than $110,000 per year filing single or $220,000 if married filing jointly, then you cannot contribute to an ESA. For most physicians, the $220,000 income limit and the $2,000 annual contribution limit make ESAs either not possible or, if possible, then an inadequate vehicle for college savings.
Uniform gifts to minors. This allows you to give money to your children and then it can be invested in any kind of investment that you (or the child) wants. You cannot deduct any contributions from your taxes and as the money grows, you’ll have to pay regular income tax on the interest and capital gains tax on the dividends and capital gains – under the current tax law, the first $1,000 of income is not taxed, the second $1,000 is taxed at the dependent child’s tax rate, and anything over $2,000 is taxed at the parent’s tax rate. Also, once the child reaches the age of majority (18-21, depending on the state), the money is theirs to do whatever they want with. So, if your idea was that they would spend it on college and their idea is that they would by a Corvette, you’ll be seeing a nice new Corvette in the driveway when he or she turns 18. Because of the lack of tax advantages and the lack of control that you have over the money once your child becomes an adult, uniform gifts to minors is not a good option for most physicians.
529 plans. These plans allow you to invest money into an account to be used for your child’s college education. The money in a 529 plan grows tax-free and as long as you use the money for college education expenses, you don’t have to pay any taxes on the withdrawals. Additionally, in some states, you can deduct contributions from your state income tax; for example, in Ohio, we can deduct up to $2,000 in annual contributions per child from our state income tax. There is no limit to the amount of money that you can put into a 529 plan but if you contribute more than $14,000 per year ($28,000 if married filing jointly) then there are tax consequences since you will have exceeded the maximum amount that the IRS allows you to “gift” to one person in one year. There are 2 types of 529 plans: (1) prepaid tuition plans that allow you to purchase tuition in selected colleges at today’s tuition rates and (2) savings plans that allow you to invest the money in state-approved investments, usually mutual funds. I’m a bit leery about the pre-paid tuition programs because if you are buying this for your newborn son, you don’t even know what state you are going to be living in 18 years from now, let alone what college he is going to want to go to. Each state has a different 529 plan that uses different mutual funds. Of note, you can invest into any state’s 529 plan that you want; for example, when these plans first came out, I invested into Iowa’s 529 plan even though I lived in Ohio and had never set foot in Iowa in my life. At the time, Iowa’s 529 plan used low-cost Vanguard mutual funds and I wanted access to them. Once Ohio switched to Vanguard funds for Ohio’s 529 plan, I moved the funds from Iowa to Ohio. The state income tax advantage that you get may only apply if you invest in your own state’s 529 plan. If you don’t need to use all of the money in the 529 account for one child, then you can very easily move the money into another child’s 529 account. If there is still a balance in your 529 accounts after you have put all of your kids through college, you can withdraw the balance of the account and use it for whatever you want but you will have to pay a federal 10% penalty on the earnings from the residual account balance. That 10% penalty may seem like a lot on the surface but it really isn’t when you figure all of the tax advantages that you have had with the money in the 529 plan over the years.
So in summary, college is expensive and will get more expensive. There are several options for saving for your children’s college education and my personal opinion is that the 529 plans are the best option for physicians. What I did with my own children was to put $5,000 into each child’s college fund account when they were born (that would be $10,000 in today’s dollars). I then put additional money into each child’s account each month. For Ohio’s 529 plan, that was easy – I set up a regular monthly direct deposit from my checking account into the 529 fund so that it happened automatically at the beginning of each month. That way, I didn’t have to think about it and I was not tempted to use the money for other purposes. At the end of the day, we put 2 of our children through private colleges and 2 through public colleges from the money in their 529 plans.
In the next post, we’ll look at insurance for physicians.
September 1, 2016