We recently covered an example to get you thinking about how much you should save each month for retirement.
With Federal tax laws in flux with the new administration, it is important to strategically plan your gifting. Saving for college presents a unique opportunity to execute a gifting strategy that will benefit both you and your child.
As an estate planning attorney in Austin, I get asked about the chances that various proposals affecting the gift and estate tax will come to fruition. Generally, it seems the momentum is on the side of a lowering of the lifetime exemption level and a raising of taxes. We will cover that in more detail in future posts. For now, let's focus on saving for college.
Here, let's try and determine how much you should be saving each year for college for your young child.
Suppose that you have a 2-year-old who shows promise by not eating too much paste during crafting projects compared to the neighbor's kid. You think wow, I may not have to support her forever. But, then you think about the potential cost of college and maybe graduate school. Perhaps you've been saving for college here and there, but not in any sort of planned manner.
If you are ready to save for your child's college in a more strategic way, read on.
I've seen estimates that college tuition inflation ranges from twice the rate of inflation to 8% a year. The latest Bureau of Labor Statistics report for Consumer Price Inflation for the last 12 months is 2.6%. Core inflation, removing the volatile food and energy prices is 1.6% for the last 12 months. The BLS estimate for inflation in Southern Texas is 2.9% for the last 6 months.
So, college tuition inflation currently ranges from about 3.2% (using CPI) or 4.2% (using core inflation) or 5.8% (using Southern Texas) to 8% a year.
Looking at the College Navigator website produced by the National Center for Education Statistics, you can look up the current tuition for the university you have your heart set on for your little scholar. I'll use UT-Austin because it serves as a non-idiosyncratic example.
In-state tuition for 2020-2021 was $11,448 plus $714 for books and supplies. UT estimates room and board at an additional $12,286 per year plus $4,480 for "other" expenses. That's a total cost of $28,928 for 2020-2021.
We are imagining that you have a 2-year-old, so we have about 16 years to save for college. Let's assume an average tuition inflation rate of our above estimates of 5.3%. This provides us with an estimated cost of four years of attending UT at $301,319.
How much should you save each year to cover the tuition for the toddler?
For this exercise let's assume that you expect a consistent annual return of 8% on your college savings. Let's also assume that you intend to increase the contribution by 10% each year as your income increases. So, a $1,000 savings this year would increase to $1,100 next year, and $1,210 the year after that.
You will save each year from 2021 to 2040 (the final year of a four-year college program).
Your goal for this saving for college project is to save the minimum amount starting in the year 2021 and to have an ending balance after the final year of college in the account of $0.
Using an optimization calculation, the minimum that you would have to save from this year would be $3,268.88.
Of course, this example uses a steady 8% rate on the college savings investment portfolio. Clients of the Law Office of Zachary D Kamykowski, PLLC can request a calculation that uses stochastic variables.
Furthermore, you can get an estimate of the chance that you'll have at least $0 in the account after the final payment.
Depending on your tolerance for risk and your current financial situation, you may be willing to invest less, more aggressively, and accept a higher chance that your child may have to take out some loans to make up the difference.
Under current federal law, you can gift up to $16,000 per year per donee (the recipient of a gift), without having to file a 709. If you and your partner coordinate gifts, you can give up to $32,000 a year to each donee.
There is an exception for funding a 529, a college savings account for a child, which allows you to consolidate 5 years of gifts into a single year. So, you could give your child's 529 up to $80,000 individually, or as a couple, $160,000 in a single year without having to file a 709 to report those gifts to the IRS.
Keep in mind that under current federal law, you have an individual lifetime gift tax exemption of $12.06m. This amount does not count the additional $16,000 per year that you can gift each year to a donee.
In Texas, because there is no state income tax, it makes sense to shop around the 50 states for the best 529 plan. You will want to consider plan options and fees when you are looking for a 529 plan to save for college on behalf of your child.
I can provide you with some recommendations about your gifting strategy and 529 selection.
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