College savings strategies for small business owners
For small business owners who have children, saving for their college education is generally a financial goal. The annual cost of college includes tuition and fees, room and board, books, transportation, and other applicable expenses. Although college tuition will vary due to certain factors (location, whether institution is public or private, whether attendee is considered an in-state or out-of-state student), a four-year degree can still be a sizable amount to prepare for. I recommend to my small business owner clients to start college savings early as possible to take advantage of compounding interest, which will make a significant difference in the long-term. This list of college savings strategies is not exhaustive (recommendations depend on each client’s individual situation), but I note some of the strategies that I commonly discuss with clients, which include 529 College Savings Plans and Custodial Accounts.
Before evaluating specific strategies, the first step for any college savings plan is to set a clear goal by establishing how much to save and a timeline. There can be no perfect calculation of how much a child’s college education will cost years from now because there are so many unpredictable factors (e.g., inflation, where child decides to attend college, potential scholarships and grants) that influence this amount, but estimating will get the process of setting a foundation started. It depends on a small business owner’s financial situation and excess cash flow, but having a lump sum amount available (to cover all college costs) at the time their child starts college might not be necessary or even the most efficient way to approach the college savings goal (i.e., taking into account that there are other areas in financial plan to allocate money to such as retirement and business growth). Small business owners could set a goal to save a specific percentage of the future college costs and plan to fund the remaining percentage with their income (excess cash flow) at the time their child is attending college. I illustrate with a hypothetical example below.
Mike has owned a fitness consulting business for 11 years. He and his wife, Mary, have one child who is five years old. In addition to their retirement savings, they have decided to start saving towards their child’s future college costs. Conservatively, they estimate what it would cost if their child attended college out-of-state.
They estimate that the total cost for four years of college will be approximately $300,000 when their child is at the age of 18.
They decide to invest $600 per month (estimated 7% rate of return), which will provide them with an amount that covers approximately 50% of the anticipated total cost.
Although they could invest more in college savings, they decide to keep a healthy balance by continuing to invest more for their retirement and maintaining financial flexibility to take advantage of business growth opportunities when available. Even further, they anticipate having a strong enough income at the time their child attends college, which will be enough to fund 50% of the anticipated total cost for which they did not save.
529 College Savings Plans
Tax benefits: investments grow tax-free, and withdrawals used for qualified education expenses are tax-free.
Flexibility: funds can be used for college tuition and K-12 education costs (note that there is a limit of $10,000 per year to be used for K-12 education costs).
Beneficiary changes: a beneficiary can be changed to another family member with no tax consequences if the original beneficiary does not need the funds. For example, if a parent has invested in a 529 college savings plan for a child that ends up getting an academic scholarship, then the funds in their 529 college savings plan could be used for their younger sibling (if applicable). Note that a beneficiary change is not treated as a distribution if the new beneficiary is a member of the current beneficiary’s family.
Custodial Accounts: known as Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts
Flexibility: funds can be used for any purpose (not just education) if it is for the benefit of the minor.
Ownership: managed by a custodian (generally a parent), but legal control of the account is automatically transferred to the child once they reach a specific age (age depends on state of residence and is typically age 18 or 21).
Beneficiary changes: not allowed to change beneficiary once it is established.
Evaluating options
I explain to my small business owner clients the importance of starting college savings early and how it can safeguard the financial future of their family (e.g., minimal or no student loan debt). I review their college savings options and recommend the best strategies for their financial situation (e.g., business performance, personal savings, existing investments). There will be some balancing between personal and business finances, but by having a plan in place provides a foundation for funding college costs that are steadily rising.