Saving for College In California: Is ScholarShare for You?

When 529 college savings plans first became available, I was a financial consultant at one of the world’s most prestigious firms. The plans were an arrow to add to the quiver, so to speak. I can tell you that ScholarShare, California’s 529 college savings plan, has improved by leaps and bounds since it was first launched. The fees are much lower, and accounts like this now make sense for almost any family.

First, I could list many statistics about how expensive college is likely to be when your kid leaves the nest. You already know that college is going to cost a fortune. There are books, tuition, living expenses, computers, and more to account for.

People who start saving money early will usually have more money saved in the end.

It’s not always because of compound interest or a larger bank balance earlier in life. It’s because you set a discipline the minute you open the account.

If you have a designated savings account open—a place to put an extra bit of cash here and there—you are more likely to actually deposit the money. I saw this happen time and time again with my own clients.

I recommend getting professional advice concerning your overall investment plan first, but you can open ScholarShare 529 account for as little as $25.

What Is a 529 Plan?

Don’t confuse a 529 college savings plan with a IRA—this is a common mistake. The 529 college savings plan is different and has many advantages:

• Earnings in the account used to pay for qualified higher education expenses will be state and federal tax-free. When you earn interest in a normal brokerage or savings account, you pay taxes on interest and dividends earned.
• Contributing to a 529 plan may reduce the taxable value of your estate, making this a popular vehicle for grandparents and other relatives to transfer wealth. You’ll definitely need to consult your tax advisor for advice.
• Anyone can open an account, though it’s important to think about who the account holder should be. It usually should be a parent. Get some advice about this as well.
• Funds can be used at private, public, trade, or graduate schools nationwide. Some overseas schools are eligible.
• Funds can be used for tuition, books, mandatory fees, supplies, certain room and board costs, and certain expenses for special needs students.
• Typically, assets are considered the primary account holder’s (parent) and do not count toward financial aid eligibility. It depends on the school, however.

What Is a ScholarShare 529 College Savings Plan?

ScholarShare is California’s 529 college savings plan. Money invested in a 529 college savings plan grows tax-deferred, and withdrawals for qualified higher education expenses at eligible higher education institutions are free from federal and California state income tax.

If money is withdrawn for non-qualified expenses, the earnings in the account is subject to state and federal tax and an additional 10% federal tax and a 2.5% California state tax. The additional taxes are often referred to as penalties. This is similar to non-qualified withdrawals from an IRA or 401 (k) before age 59 1/2.

How Does ScholarShare Work?

ScholarShare operates the 529 plan in California (each state has its own). The fees for ScholarShare are some of the lowest 529 fees in the country.

In fact, they are quite low, in general. There’s no initial fee, just a minimal annual fee that’s a percentage of the account balance. This is normal for mutual funds and ETFs. The fee depends on the portfolio.

• Allocate your funds between multiple portfolios based on your comfort level and the age of your child.
• There are no income limitations. It doesn’t matter how much money you make, you can have a ScholarShare 529 plan.
• If you move out of state, you can keep ScholarShare.
• A ScholarShare account can have a maximum balance of $529,000. After this point, the account can continue to accrue interest but you may not contribute further to it.
• You may transfer the account to another beneficiary.
• The plan is managed by TIAA-CREF Tuition Financing.
• Accounts have online access.

The most common question that I would get in regard to these accounts is the following.

What Happens if My Child Decides Not to Go to College?

Not to worry, your money isn’t lost if your child decides not to go to college. Keep in mind that ScholarShare funds can be used for college, graduate school, trade school, and other eligible credentials.

If you decide not to transfer the account to another beneficiary, you can access the money. The earnings portion would be subject to federal and state tax (just like a normal account), plus a 10% penalty. You will always be able to access your money. (Learn more about what happens if your child gets a scholarship, how the account impacts financial aid, and more with this helpful college savings plan FAQ below).

What if My Child Chooses Not to Attend an Eligible Institution or Skips College Entirely?

You may change the beneficiary to another family member. Or, you can make a non-qualified withdrawal which is subject to state and federal taxes, an additional 10% federal tax and an additional 2.5% California state tax.

In the event that you need to make a non-qualified withdrawal due to the death or disability of your child, you may withdraw the money without penalty. The earnings in the account would be subject to state and federal taxes, just like they are in any other brokerage account.

In what feels like the blink of an eye, we have a second grader on our hands. This school year flew by at warp speed so I can imagine the next 11 years before she goes to college will, too. Eleven years is shorter than the length of time I’ve been married and it isn’t that far away.

What Are the Eligible Higher Education Institutions?

Eligible higher education institutions include:

• College
• University
• Community college
• Trade/career/technical schools
• Any type of degree or certificate program
• Graduate degrees

A number of accredited foreign institutions qualify, too. Contact the institution of interest to verify or check the Federal School Code Search.

What Are Qualified Expenses?

The student must be enrolled at least half of the time or full time. Qualified expenses include:

• Tuition
• Mandatory fees
• Certain room and board costs (if a child is living with parents, this can be a qualified expense—ask your financial adviser how much you may be able to withdraw as room and board reimbursement)
• Books
• Mandatory equipment and supplies

What if My Child Receives a Scholarship?

Talk to a financial adviser for specifics but there is some leeway here. You may withdraw 529 principle funds up to the amount of the scholarship—provided the scholarship covers qualified expenses, which they usually do—without penalty or additional tax. If there are earnings withdrawn to cover the scholarship value, these will be subject to federal and state tax without any additional taxes applied.

Earnings withdrawn from the ScholarShare account in excess of the scholarship value that aren’t used for qualified expenses, however, will be subject to federal and state tax, an additional 10% federal tax and an additional 2.5% California state tax.

What if My Child Enrolls in a Military Academy?

Thanks to the Military Family Tax Relief Act of 2003, attendance at a U.S. military academy will be treated as a scholarship (above) for purposes of non-qualified withdrawals from a 529 plan. The value of the education can be withdrawn without penalty though the earnings portion will be subject to tax, just like a scholarship. Talk to your financial adviser about how this will impact you.

Does Having a 529 College Savings Plan Impact Financial Aid Eligibility?

A number of parents shy away from 529 college savings plan because they fear it will impact their child’s ability to qualify for financial aid. Here is the deal… Any asset owned by a parent or the child enrolling in college will be considered on a financial aid application.

A 529 college savings plan is usually considered to be the asset of the owner. Owners can be parents, grandparents, aunts, uncles, friends or anyone relevant in your child’s life.

If the owner is the parent, 5.6% of the 529 college savings plan balance is considered as Expected Family Contribution (EFC), which is used to determine how much financial aid a student is eligible to receive. Most parental assets are considered at 5.6%.

EFC is calculated using a formula that is established by law, but I’ve read that the consideration of investments in a ScholarShare account varies by school. Things that go into consideration may include family size, income, government benefits (like social security) and number of kids who will attend college in the same year. Refer to the EFC guide for in depth details.

Custodial savings accounts such as UGMA or UTMA accounts (in my past life as a financial adviser, I could not see why anyone would open these but this is another can of worms) are counted as 20% toward EFC, negatively affecting a financial aid application much more than a 529 plan would.

A 529 college savings account owned by grandparents, aunts, uncles or anyone else that isn’t the student or the student’s parents doesn’t count toward Expected Family Contribution. But, be cautious about deliberately structuring a financial plan that involves other people. I’ll leave it at that.

I Can Afford to Send My Child to College. Why Should I Open a 529 Plan?

In this case, the tax-free growth and tax-free qualified withdrawals are of the most benefit to a person in this scenario, who may also be in a higher tax bracket.

However, you will want to work closely with your financial adviser and perhaps be diligent about only saving only the amount necessary to cover your child’s college expenses in order to avoid the 10% penalty and taxes. Remember, if there are funds leftover when the beneficiary is finished withdrawing, you may gift the account to another family member or use it for your own higher education expenses.

In our case, our ScholarShare 529 college savings plan is a much more tax advantageous way to save than our regular brokerage account. But we have no plans to overfund it. In fact, based on my own personality, I’d rather underfund it slightly and not worry about a penalty.

Seeing that if my daughter chooses Harvard, my husband’s alma mater, we’re facing a tab of approximately $440,000 including room and board so I’m not to stressed yet about hitting a penalty. However, should she choose UC San Diego or another school with significantly less tuition expense than Harvard, that might leave a few hundred thousand extra in the account that we would need to make a non-qualified withdrawal to release since we only have one child.

Ultimately, if you’re in a position to fully fund a college savings account to cover the entire cost of college, talk to your financial advisor to help decide what you are most comfortable with.

How Much Will College Cost When Your Kids Go?

The schools that my daughter is likely to attend run the gamut when it comes to price. Thankfully, there are college savings calculators out there that will help you estimate the amount you need to save including room, board, and textbooks.

Cost of College for Today’s 7-Year-Old

I graduated from the University of California at San Diego and my husband graduated from Harvard University. Here’s what we’re looking at if our 7-year-old daughter chooses either of these schools eleven years from now.

University of California at San Diego current estimated costs with in-state tuition:

• $33,849 per year, including room and board

Estimated cost of UCSD in 11 years with in-state tuition:

• $281,093 total for four years ($70,273 each year), including room and board

Harvard University estimated current costs:

• $73,080 per year, including room and board

Estimated cost of Harvard University in 11 years:

• $612,859 total for four years ($153,214 each year), including room and board

My husband also rightly points out that these costs don’t include flights back and forth to home (if applicable), pocket money, cell phones, and other incidentals. Either option requires a huge investment on our part.

How to Estimate the Cost of College

ScholarShare, California’s 529 college savings plan, has a college savings calculator online that allows parents to plug in their child’s current age, desired college (exact colleges are listed), tax rate, rate of expected return on investment, and amount of planned savings.

The calculator will generate a shortfall and tell you what you need to invest to meet the need or (hopefully) reveal that a surplus is in your future.

It’s very easy to play around with. Check it out. Knowledge is power… that’s why we’re saving all of this money for college, right?

Why Your Child Needs a 529 College Savings Plan Now

Studies show that saving for college regularly is one of the best ways for families to accumulate the funds necessary for the rapidly rising cost of higher education.

Why Parents Who Can Afford to Aren’t Saving for College

Procrastination is one major reason. Parents are so overwhelmed by the cost of college that even if they can afford to save a little, they aren’t doing it.

The problem of no or not nearly enough savings is perceived as so big that parents don’t want to address it.

I’ve personally dealt with clients like this who had multiple kids in the junior high/high school range. Imagine hearing that you need to save thousands of dollars per month going forward… and even that won’t cover the entire cost of tuition. It’s incredibly—and understandably—disheartening.

What happens next? Almost half the clients I dealt with threw in the towel and half would open a college savings account that they didn’t fund as much as they could have. A very small percentage buckled down and saved aggressively.

I believe another reason parents who can aren’t saving for college is because they don’t understand the benefits and flexibility of the ScholarShare plan, which is part of the reason for this post.

Why Procrastinating Means Long-Term Consequences for the Kids

The obvious answer is that not saving enough for a child’s education means that it’s up to the child to earn scholarships or take out financial aid. A lot of parents understandably rely on this backup plan.

As someone who graduated college without debt, I hadn’t thought about how having debt can change your life in the future.

Graduating college with less debt means less risk of children delaying major life events for financial reasons.

This could be anything from:

• starting a retirement account sooner and with higher contributions.
• a larger down payment on a first-time home purchase.
• greater ability to start and provide for a family.
• starting a career they love versus one for the paycheck.
• funds to pursue one’s dreams.

Or, they could decide not to go to college because they are overwhelmed by the six-figure tab. It would take years and years to pay that off, even with low interest.

Why ScholarShare?

Again, ScholarShare is California’s 529 college savings plan that is named for the section of the IRS code under which it is created. Here are ten of many important facts about ScholarShare:

1. It’s managed by TIAA-CREF, famous for conservative strategies and excellent performance.
2. The fees are incredibly low. In fact, they are lower than many retail mutual funds.
3. Anyone (grandparents, aunts, uncles, friends) can open a ScholarShare account for any child, even if the parents have one already.
4. Anyone can contribute to an existing ScholarShare account.
5. Morningstar, which ranks mutual funds, name ScholarShare as one of the nine best college savings plans in the nation.
6. There are a wide variety of investment options.
7. Earnings grow tax-deferred.
8. Disbursements, when used for tuition and other higher education expenses, are federal and state tax-free.
9. The account can be used at any higher education facility that is eligible for federal funding. This includes some overseas universities and trade schools.
10. An account can be opened with as little as $25.

Here’s another interesting statistic:

Kids who know they have a college savings account are seven times more likely to go to college.

Studies have shown that this is a better predictor than race or parents’ net worth. See this article by the Washington Post.

Give ScholarShare as a Gift

During holiday and birthday giving seasons, it’s easy to gift the child in your life something with more longevity than a toy or gadget.

A deposit as small as $25 can be made into a ScholarShare 529 college savings account. It is often done as part of a larger gift, too, if you’d like also to give the child something immediate and tangible.

How? Contribute to an existing ScholarShare account or open up a new one with the child as beneficiary. It’s actually much easier than it sounds.

Gift to an Existing ScholarShare Account

If the account is existing, it’s easiest to download a ScholarShare gift deposit form. Ask the account owner for the account number. Write a check to ScholarShare College Savings Plan. Be sure to include the account number on the check and then mail it in with the deposit form.

Alternatively, you can present the recipient with a check and gift deposit form and let them fill in the account number. This is what I would likely do.

Gift a New ScholarShare Account

If the child doesn’t yet have a ScholarShare account, then you would complete the application process which can be done online in about 5 minutes. Or, request a paper application. You will need to know the child’s social security number, however. And, remember that a beneficiary can have more than one ScholarShare account.

Print a Special Gift Certificate for the Occasion

Download a ScholarShare gift certificate to accompany your contribution. Gift certificates are themed by occasion from baby showers to birthdays to any occasion. This is a great way to let the account owner know that you send a gift if the check didn’t pass directly through their hands.

Drop the Hint to Friends and Relatives

Friends and relatives won’t know to gift money to a 529 college savings account without parents or the child mentioning it. Send them an email and include the link to the gift deposit form. Let them take it from there. No pressure.

Other Things to Know

The generous folks who send in gifts to existing accounts don’t have any access to your account. They can’t change investment allocations or see balances. Gifted funds are invested according to the account’s pre-determined investment allocation.

Do you have a ScholarShare 529 College Savings Plan?