Roth vs. Traditional IRA: Which is best for you?

Kali Hassinger Contributed by: Kali Hassinger, CFP®

Roth vs Traditional IRA: Which is best for you?

If you’re planning to use an IRA to save for retirement, but aren’t sure whether Roth or Traditional is best for you, we can help sort it out. Before we break down the pros and cons of each, however, we need to make sure that you are eligible to make contributions.

For 2019 Roth IRA contribution rules/limits:

  • For single filers, the modified adjusted gross income (MAGI) limit is phased out between $122,000 and $137,000. (Unsure what MAGI is? Click here.)

  • For married filing jointly, the MAGI limit is phased out between $193,000 and $203,000

  • Please keep in mind that it makes no difference whether you are covered by a qualified plan at work (such as a 401k or 403b). You simply have to be under the income thresholds.

  • The maximum contribution amount is $6,000 if you’re under age 50. Those who are 50 and older (and have earned income for the year) can contribute an additional $1,000 each year.

For 2019 Traditional IRA contributions:

  • For single filers who are covered by a company retirement plan (401k, 403b, etc.), in 2019 the deduction for your IRA contribution is phased out between $64,000 and $74,000 of modified adjusted gross income (MAGI).

  • For married filers covered by a company retirement plan, the deduction is phased out between $103,000 and $123,000 of MAGI.

  • For married filers not covered by a company plan, but who have a spouse who is covered, the deduction is phased out between $193,000 and $203,000 of MAGI.

  • Maximum contribution amount is $6,000 if you’re under age 50. Those who are 50 and older (and have earned income for the year) can contribute an additional $1,000 each year.

If you are eligible, you may be wondering which makes more sense for you. Well, as with many financial questions…it depends! 

Roth IRA Advantage

The benefit of a Roth IRA is that the money grows tax-deferred. When you are over age 59 ½, you can take the money out tax free. However, in exchange, you don’t get an upfront tax deduction when investing in the Roth. You are paying your tax bill today, rather than in the future. 

Traditional IRA Advantage

With a Traditional IRA, you get a tax deduction for the year you contribute money to the IRA. For example, a married couple filing jointly with a MAGI of $190,000 (just below the phase-out threshold when one spouse has access to a qualified plan) would likely be in a 24% marginal tax bracket. If they made a full $6,000 Traditional IRA contribution, they would save $1,440 in taxes. To make that same $6,000 contribution to a ROTH, they would need to earn $7,895, pay 24% in taxes, and then make the $6,000 contribution. The drawback of the traditional IRA is that you will be taxed on it when you begin making withdrawals in retirement.

Pay Now or Pay Later?

It’s challenging to decide which account is right for you, because nobody has any idea what tax rates will be in the future. If you choose to pay your tax bill now (Roth IRA), and in retirement you find yourself in a lower tax bracket, you may have been better off going the Traditional IRA route. However, if you decide to make a Traditional IRA contribution for the tax break now, and in retirement find yourself in a higher tax bracket, then you may have been better off going with a Roth. 

How Do You Decide?

A lot depends on your situation, such as the career path you’ve chosen and your desired income in retirement. However, we typically recommend that those just starting their careers (who will most likely see their incomes increase over the years) make Roth contributions. If your income is stable, and you’re in a higher tax bracket, a Traditional IRA and immediate tax break may make more sense now.

Before making any final decisions, it’s always a good idea to work with a qualified financial professional to help you understand what works best for you.

Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.


UPDATED from original post on June 19, 2014 by Matt Trujillo, CFP®

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Kali Hassinger, CFP®, CDFA®, and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. You should discuss any tax matters with the appropriate professional.

Climate Change and What It Means for Investors

Jaclyn Jackson Contributed by: Jaclyn Jackson

Climate Change and What it Means for Investors

Coming in 1.71°F above its historical average of 59.9°F, June 2019 was the hottest June globally in 140 years of recorded data. June’s temperature increase is the latest in an upward trend that began in the 1970s. While debates hotter than any June persist about the validity of global warming, the fact remains that climate change carries significant implications for individuals, industries, and investors alike.

Global Temperature Differential Relative to June Historical Average

Industry and Economic Impact

Not convinced Mother Nature can wreak havoc on your day-to-day life? Just ask any New Yorker who recently experienced a heatwave, flooding, and power outages all in the same week. In fact, there’s no need to look that far; as of this writing, some Detroiters are still hoping to regain power after incredibly warm weather hit the region.

While it’s pretty clear how extreme weather conditions generate problems for energy companies, heatwaves can disrupt other industries. Manufacturing plants experience reduced production when temperatures soar above 90 degrees; fewer people look for homes, which affects the real estate industry’s most active season; and increased hospitalizations impact insurance companies. While these problems more directly speak to developed, urban areas and industries, they don’t even begin to define the potential implications of climate change around the globe.

Goldman Sachs summarized it best: “We believe that in addition to environmental impact, direct damage from mortality, labor productivity, agriculture, energy demand, and coastal storms may also significantly impact overall economic growth.”

Investors Demand More

It’s no wonder 477 global investors (including money managers and large pension funds around the world) issued a letter to governments attending the G-20 summit in Osaka, Japan. Commanding $34 trillion in assets, they’ve concluded that ignoring the Paris Agreement’s mission would create “an unacceptably high temperature increase that would cause substantial negative economic impacts.” Investors created the letter to petition government leaders to achieve the 2015 Paris Agreement goals, accelerate private sector investment into low carbon transition, and commit to improved climate-related financial reporting.

Be the Change

These investors also use their substantial financial weight to speak with companies in their portfolios about how they are addressing and alleviating industry-specific climate change issues. Individual investors can take a similar approach, by using their financial power to invest in mutual/exchange traded funds that evaluate the environmental, social, and governance (ESG) qualities of companies in their portfolios, as well as more traditional methods of research.

Are you ready to be the change?

Learn more about The Center’s Social Portfolio and ESG investing here.

Jaclyn Jackson is a Portfolio Administrator at Center for Financial Planning, Inc.® She manages client portfolios and performs investment research.


Investors should carefully consider the investment objectives, risks, charges and expenses of Mutual Funds and Exchange-Traded Funds (ETFs) before investing. The prospectus and summary prospectus contains this and other information about Mutual Funds and ETFs. The prospectus and summary prospectus is available from your financial advisor and should be read carefully before investing.

Opinions expressed are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

SOURCES: https://www.pionline.com/esg/investor-group-pleads-g-20-global-warming https://theinvestoragenda.org/wp-content/uploads/2019/06/FINAL-at-June-24-Global-Investor-Statement-to-Governments-on-Climate-Change-26.06.19-1.pdf

The Power of Working Longer

Nick Defenthaler Contributed by: Nick Defenthaler, CFP®

The Power of Working Longer Center for Financial Planning, Inc.®

Saving 1% more towards retirement for the final 10 years of one’s career has the same impact as working one month longer.

Yes, you read that correctly. Saving 15% in your 401k instead of 14% for the 10 years leading up to retirement has the same impact as delaying retirement by only 30 days! Hard to believe but that’s exactly what the National Bureau of Economic Research found in their 2018 research paper titled “The Power of Working Longer”. To make your eyes pop even more, consider that saving 1% more for 30 years was shown to have the same impact as working 3-4 months longer. Wow!

If you’re like me, you find these statistics absolutely incredible. This clearly highlights the impact that working longer has on your retirement plan. As we’re getting very close to retirement (usually five years or less), most of us won’t be able to make a meaningful impact on our 25-35 year retirement horizon by increasing our savings rate. At this point in our careers, it just doesn’t move the needle the way you might think it would.  

Without question, the best way you can increase the probability of success for your retirement income strategy in the latter stages of your career is to work longer. But when I say “working longer”, I don’t necessarily mean working longer on a full-time basis.  

A trend I am seeing more and more, one that excites me, is a concept known as “phased retirement”. This essentially means that you’re easing into retirement and not going from working full-time to quitting work cold turkey. We as humans tend to view retirement as “all on” or “all off”. If you ask me, that’s the wrong approach. We need to start thinking of part-time employment as part of an overall financial game plan.  

Let’s look at a real-life client I recently encountered (whose name was changed to protect identity):

Mary, age 62, came in for her annual planning meeting and shared with me that the stress of her well-paying sales position was completely wearing her down. At this stage in her life and career, she no longer had the energy for the 50-hour work weeks and frequent travel. Now a grandmother of three, she wanted to spend more time with her kids and grandkids but feared that retiring at 62, compared with our plan of 65, would impact her long-term financial picture.  

The more we talked, the more clear it became that Mary did not want to completely stop working; she just could not take the full-time grind anymore. When we put pen to paper, we concluded that she could still achieve her desired retirement income goal by working part-time for the next three years (to get her to Medicare age). Her income would drop to a level that would not allow her to save at all for retirement, but believe it or not, that had no meaningful impact on her long-term plan. Earning enough money to cover virtually all of her living expenses and not dipping into her portfolio until age 65 was the key factor.

Having conversations around your desired retirement age is obviously a critical component to your overall planning. However, a sometimes overlooked question is, “WHY do you want to retire at that age?”. As a society, we do a good job of creating social norms in many aspects of life, and retirement is not immune to this. I’ve actually heard several clients respond to this question with, “Because that’s the age you’re supposed to retire!”. When I hear this, I get nervous, because these folks usually make it three months into the retirement transition, only to find they are not truly happy. They found purpose in their careers, they enjoyed the social aspects of their jobs, and they loved keeping busy, whether or not they realized it at the time.

The bottom line is this: Don’t discount the effectiveness of easing into full retirement, both from a financial and lifestyle standpoint.

Some clients have found a great deal of happiness during this stage of life by working less, trying a different career, or even starting a small business they’ve dreamed about for years. The possibilities are endless. Have an open mind and find the balance that works for you, that’s what it’s all about.

Nick Defenthaler, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® He contributed to a PBS documentary on the importance of saving for retirement and has been a trusted source for national media outlets, including CNBC, MSN Money, Financial Planning Magazine, and OnWallStreet.com.


The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss.

Women’s Leadership as an Investment Concept

Center for Financial Planning, Inc.® Women's Leadership

REPOST

Did you know three of the five partners at The Center are women? We live the value of gender diversity in the ownership and leadership of our firm.

Women’s leadership can and should also be understood as an investment concept.

Many studies have shown that women bring a unique perspective to senior and executive management roles within firms. This “secret ingredient” adds profitability, better risk preparedness, more collaboration, and more innovation to companies. 

An emerging consensus recognizes that the status and roles of women may be an excellent clue to a company’s growth potential.

Despite this, a large wage gap persists between women and equivalent men in the workforce, and there’s very little gender diversity among senior management and corporate boards.

Many barriers affect female participation in management and the boardroom.

One of the most easily understood is time out of the workforce.

Women spend an average 12.6 years out of the workforce to care for children or parents, whereas men only spend an average of 10 months outside the workforce!

This pull between work and family responsibilities likely has a lot to do with the disparities that still exist. After reading Lean In by Sheryl Sandberg, COO of Facebook, I discovered that barriers within ourselves also prevent women from climbing the corporate ladder. There are days when I long to be able to spend more time at home with my daughter, but I also recognize the importance of being the role model of a woman who is happy and successful in her career, as well as enjoying quality family time. My daughter also gains the benefit of seeing a father who is very engaged and shares the responsibilities of parenting, who is a real partner to me. This rhythm works for us. Finding your family’s own rhythm and peace is of utmost importance.

Sharing ideas and our own experiences is part of the solution. Another potential solution is using your investments to express your viewpoint with your dollars. If you would like to learn more, please contact your financial planner!

Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.


Any opinions are those of Angela Palacios, CFP®, AIF® and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Raymond James is not affiliated with and does not endorse the opinions or services of Sheryl Sandberg or Facebook. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Women & Investing: How to Better Engage With Your Finances

Laurie Renchik Contributed by: Laurie Renchik, CFP®, MBA

Center for Financial Planning, Inc.® Women and Investing

REPOST

Working with women over the last 20 years has taught me that we can’t help our families, our communities, or the world if we don’t understand how money works. I have seen firsthand that when women are engaged in financial decisions, as both professionals and as consumers, we can tip the scales and improve all women’s ability to lead and understand the influence of money on financial independence.

If you are a busy, multi-tasking woman, the first step is usually the most difficult. Once you decide to pull a financial plan together, the pieces start to fall nicely into place. Having trouble with those first steps?

Practical advice to get you started:

  • Give your personal financial life the attention it needs. If you feel like life is whizzing by, take time to step back and ask, “Am I on the right track?”. Implementing a financial plan serves as a point of reference for staying on track.

  • If your goals change along the way, make timely adjustments. You probably have at least a vague picture in your head of what you want in the future. The beauty of the financial planning process is that it makes conversations happen, especially with the help of a financial planner who can serve as a thinking partner.

  • Pull a team together. Your financial planner, tax preparer, and attorney can help you keep your arms around the different aspects of your financial plan. They’ll also recommend course corrections when necessary and chart the progress as you go.

Practical advice to keep you on track:

  • Continue to ask questions. Financial planning means asking, “Where do I want to be in 3 years?, 10 years?, 20 years?”. This may change as you go along.

  • Stick to your plan. Good financial habits are a foundation upon which you can build for a lifetime.

  • Stay focused on your priorities. A good plan will help you remember what is most important in your life and decide how your financial resources can help you get there.

The future is not the finish line; it is just the beginning, if you have the resources to lead the life you want. Is there a better reason to become more engaged with your finances and put your plan together?

Laurie Renchik, CFP®, MBA, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With 20 years of industry experience, she specializes in proactive retirement planning and helping clients assess risk in their portfolios.


This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Laurie Renchik, CFP®, MBA and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected.

Webinar in Review: Part 3: Divorce & Finance 101 for Michigan Women

Jacki Roessler Contributed by: Jacki Roessler, CDFA®

REPOST

I’ve been working with divorcing clients and their attorneys for well over 20 years now. Although every single case I’ve worked on has had its own unique issues and challenges, most initial appointments follow a similar trajectory. First and foremost, I always want to hear what the person in front of me is most concerned about.  In fact, I want to hear ALL of their financial concerns and questions relative to the divorce.

Once their concerns are on the table (and in my notepad), I find that most clients need education on the basics.  In fact, it’s been a rare first meeting that doesn’t end with me stepping up to a white board to present what I call “Divorce Finance 101”. If my client doesn’t understand the key issues that surround child support, alimony and property division, we can’t even begin to address concerns about handling a family-owned business, paying for college costs, substantiating the need for alimony or what may or may not be considered separate property.

The webinar that follows is a compilation of my favorite topics from “Divorce Finance 101”. A few words of warning. This information is fluid. It changes over time as State, Federal and tax law changes occur.  There are always exceptions to all the “basic rules” too, of course. Most importantly, I am not a lawyer and therefore cannot provide legal advice. I can only give information based on my professional experience. My most important piece of advice to any client is how critical it is to hire a qualified, experienced family law attorney that practices often in your county court system.

As always, please feel free to contact me at jacki.roessler@centerfinplan.com for any questions that are specific to your case or if you have any future webinar topics you’d like to suggest.

Jacki Roessler, CDFA®, is a Divorce Planner at Center for Financial Planning, Inc.® and Branch Associate, Raymond James Financial Services. With more than 25 years of experience in the field, she is a recognized leader in the area of Divorce Financial Planning.


Any opinions are those of Jacki Roessler and not necessarily those of Raymond James. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

3 Things a Widow Can Do to Gain Financial Control

Sandy Adams Contributed by: Sandra Adams, CFP®

Center for Financial Planning, Inc.® 3 Things a Widow Can Do to Gain Financial Control

REPOST

Typical of most couples, my clients Mike and Sue evenly split the household chores. She handled the house – decorating, cleaning, meals, etc. He handled the cars and the finances, including paying the bills.

A retired engineer, Mike loved cars, and he loved numbers and details. Sue hated all of that numbers stuff – so much so that, for the most part, she didn’t even attend annual meetings with their financial advisor. Over the last few years, I offered to meet at their home so she would be involved in the financial review. I felt it was important that Sue have at least a basic understanding of what was going on.

When Mike unexpectedly died in a car accident, a man taken way too young in his mid-70’s, Sue felt completely unprepared, as most of us would, for a life alone. Her children lived nearby, so that was comforting. From a financial perspective, she at least knew what she had to work with and knew who to call. We were able to speak shortly after Mike’s death.

In the months that followed, Sue gave herself time, as we recommended, to not make any big decisions and to find her new normal without Mike. This involved figuring out what her new cash flow looked like; she eliminated some services and added others, etc. Sue also worked her way through Mike’s bill paying system. Very detail oriented and complicated, it was way too rigorous for her tastes. But she felt, somehow, that she needed to stick to his system, because it had always worked for them.

My suggestion to Sue (and to any widow) as she takes control of her own financial affairs after the death of a loved one is this:

  1. Take the time to figure out what your new normal is and what changes can be made to fit your new lifestyle.

  2. Use a system that makes things easy for you. Don’t stick to a system that makes you crazy just because it’s the one that your deceased spouse used for years.

  3. Use your financial advisor as a partner/coach to help guide you through the process as you take control of your financial life. If this is new, it could take a year or two for you to feel comfortable with the process. And that’s okay.

Becoming a widow at any age is challenging enough, without facing the additional hurdles of handling things for which you weren’t responsible in the past. Use your resources and give yourself permission to design your financial life to fit your new normal.

Sandra Adams, CFP®, CeFT™, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She specializes in Elder Care Financial Planning and serves as a trusted source for national publications, including The Wall Street Journal, Research Magazine, and Journal of Financial Planning.


Any opinions are those of Sandra D. Adams, CFP® and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. The case study is a hypothetical example provided for illustrative purposes only. Individual cases will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Prior to making any investment decision, you should consult with your financial advisor about your individual situation. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Webinar in Review: What Donors Want

Jaclyn Jackson Contributed by: Jaclyn Jackson

If your nonprofit hopes to develop meaningful relationships with donors, this webinar recording is for you. Learn what donors want to know before working with charities, how to make it easier for donors to support your work, and why endowments are important for meeting your organization’s goals.

If you missed the webinar, here’s a recording:

Check out the time stamps below to listen to the topics you’re most interested in:

0:00 Intro and Agenda

What Donors Want to Know:

  • 2:30 Grant Review Feedback

  • 09:20 Financial Review Feedback

Make it Easier for Individual Donors to Support Your Work:

  • 15:00 Donor Advised Funds

  • 17:00 Qualified Charitable Distributions

Meeting Your Organizations Goals:

  • 19:00 Endowments

  • 22:00 Working with Financial Advisors

Long Term Care Premium Increases — Things to Consider if You Receive a Notice

Sandy Adams Contributed by: Sandra Adams, CFP®

Long Term Care Premium Increases

No one likes to receive a letter stating that their premiums are going up — especially with a Long Term Care insurance policy that already seems relatively expensive. Unfortunately, when you own something other than a “paid up” Long Term Care Insurance Policy, the question is not if but when you might receive such a notice. To review, remember that the law allows insurers to apply to regulators for an increase in premiums.

Increases are allowed only if they apply to all policyholders and the company’s data shows current premiums will not cover current and future claims based on costs, projected interest rates, projected increases in claims or length of claims. (Companies cannot increase premiums for specific individuals based on increases in age, gender, health conditions, or filing of a claim.)

Taking the time to make an educated decision about your options when a premium increase occurs is crucial when it comes to Long Term Care insurance, especially as you get older. The more time passes, the greater the likelihood that you might need this type of insurance.

If you are faced with a premium increase, you typically have a limited number of options: 

  1. Pay the increased premium and keep your current coverage.

  2. Continue to pay your current premium or a reduced premium and accept some combination of reduced benefits (likely in this category, your Long Term Care insurance company will offer you a short list of options from which to choose). *NOTE: We have recently discovered that the list of options provided WITH the premium increase are not the only options. If you wish to consider additional options, you (and/or you advisor) can contact the Long Term Care company to request additional options. For example, a client in their mid-80s may consider an option to discontinue the compound inflation rider going forward and considerably decrease the premium. The added benefit for someone in their mid-80s is negligible at that point.

  3. Take the Contingent Non-Forfeiture Option. If the percentage of premium increase is at a certain level, you may be able to stop paying premiums, and you would be entitled to a long-term care benefit based on the amount of premium dollars you have already paid.

It makes sense to carefully weigh your options when it comes to the Long Term Care insurance decision. Understand that you have full control. The Long Term Care insurance company will provide additional options if you request them — but you have to ask. And work with your financial advisor to review your options and see what makes sense. The only option that likely DOES NOT make sense is NOT writing the check to the Long Term Care insurance company at all!

Sandra Adams, CFP®, CeFT™, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She specializes in Elder Care Financial Planning and serves as a trusted source for national publications, including The Wall Street Journal, Research Magazine, and Journal of Financial Planning.

3 Reasons to Get an Early Start on College Savings

Robert Ingram Contributed by: Robert Ingram

Get an Early Start on College Savings

The back-to-school season is right around the corner. And if you have school-aged children, the thought of planning for their college education may be enough to cause your own case of back-to-school jitters. Costs of a four-year education at many colleges and universities are already well into the six-figure range (per child!). For many families hoping to cover a large portion of the costs, significant savings goals are likely required. That’s why, more than ever, you should create a college savings plan as early as possible. 

College Costs Keep Rising

When planning to fund an education goal that may be years away, focusing on today’s costs is (unfortunately) just the beginning. Like the prices of many other goods and services, college costs have increased over time. These costs, however, have been rising much faster than those of other household expenses. According to JPMorgan Asset Management’s research, tuition costs have grown by an average annual rate of 6.4% since 1983. At this rate, today’s cost of tuition would double in about 11 years. Even if this rate of inflation slowed somewhat, potential college costs are eye-opening.

The illustration below shows projected total tuition, fees, and room and board expenses for a four-year, public or private college education, with a 5% annual increase in costs.

Source: JPMorgan Asset Management College Planning Essentials, using The College Board,  2018 Trends in College Pricing . Future college costs estimated to inflate 5% per year. Average tuition, fees and room and board for public college reflect four-year, in-state charges.

Source: JPMorgan Asset Management College Planning Essentials, using The College Board, 2018 Trends in College Pricing. Future college costs estimated to inflate 5% per year. Average tuition, fees and room and board for public college reflect four-year, in-state charges.

As you can see in this example, a child who is 10 years old today could expect a total cost of $136,085 at an in-state public college or university. Her education at a private college could cost over $308,000.

The power of compound growth on your savings and invested earnings can be one of your best allies as you save for these potential future costs. Let’s say the family of our 10-year-old child began saving $3,600 each year. At 7% growth compounded annually, they would have $36,935 by the time she turned 18. What if, instead, they began saving that same amount eight years earlier, when the child was age 2? At the same 7% annual return, they would have $100,396. The sooner you can begin saving and investing, the more time compounding has to work its magic.

The Burden of Student Loan Debt

As the costs of college have continued to rise, the amount of student loan debt has grown as well. A recent report from the New York Federal Reserve Consumer Credit Panel showed that outstanding student loan debt totaled $1.44 trillion as of September 30, 2018. In addition, studies from the Institute of College Access and Success found that 65% of students graduating in 2017 from public and private, non-profit colleges had student loans, and the average borrower owed $28,650.

Loans can help provide students the funds to complete their educations, but a large debt balance can have serious implications for a graduate’s personal finances. As new graduates begin their careers, servicing this student loan debt can take up a large portion of their budgets. More dollars going to pay down debt means fewer dollars available for other needs, for building an emergency fund, saving for a house, or saving for retirement. (Click here to see some financial tips for new graduates). Parents managing student loan debt can also feel similar constraints. Often, parents in the home stretch toward retirement are paying down debt instead of funding their own retirement plans. 

Of course, every dollar of college expenses paid from savings can mean one less dollar of debt to service. More than that, the longer you have to build college savings, the greater the difference between the out-of-pocket cost of paying for college with debt and the out-of-pocket cost of saving. Take a look at the following chart, which compares the cost of funding education through loans (the principal borrowed and interest) with the cost of saving over 18 years.

529 college savings plan vs. college loan

In this hypothetical example, the total out-of-pocket amount of $65,800 contributed to the savings plan combined with investment earnings of 6% annually provided the total balance of $117,698. Borrowing that same $117,698 could result in total spending of $168,390 for the loan principal and interest.

What about Financial Aid?

If you’re like many clients thinking about college planning, you may be concerned that your savings and investments will negatively affect your eligibility for college aid. You might be worried that the more you save, the less likely it is that you will receive assistance.

To determine financial aid eligibility, schools use an Expected Family Contribution (EFC), which is a measure of a family’s financial strength. The EFC formula takes into account the incomes and assets of both the student and the parents. While the amount of savings and investment assets are considered, assets – and particularly those held in parents’ names – are a much smaller factor than incomes.  

The EFC formula includes up to 50% of the student’s income and 47% of parents’ income. On the other hand, the EFC considers up to 20% of the student’s assets and only 5.64% of the parents’ non-retirement assets, above a protected amount. Although balances in college savings plans are counted along with other non-retirement assets, the smaller percentage applied to parental assets can allow parents to build some meaningful savings without drastically affecting their student’s EFC. For a closer look at the financial aid process, check out our college planning webinar.

As with other areas of financial planning, college savings involves balancing your goals and priorities in order to most effectively align your resources. Your own unique circumstances will determine the right amounts to save, and when and where to save. If we can be a resource for any of your college planning needs, please let us know!

Robert Ingram, CFP®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® With more than 15 years of industry experience, he is a trusted source for local media outlets and frequent contributor to The Center’s “Money Centered” blog.