Oklahoma college savings plan

Saving for college can be daunting task, especially in families with multiple children.  Our financial planning clients often list college expenses as their second most important goal after retirement.  Unfortunately, many people aren’t aware that there are very specific investment products designed to help you save and use the power of compound interest to make the process easier.  With proper planning and foresight, paying for college expenses can easily be incorporated into your families budget, and you’ll have a lot less stress 18 years down the road when your son or daughter is getting ready to leave the nest for the very first time.

There are three main education specific options to save for college within an investment account, and the details for each can vary by state. 

Prepaid Tuition Programs

The first option is to prepay your child’s college tuition years in advance, aptly called a prepaid tuition program.  Some of these plans are offered within 529 plans for public schools (Florida, Illinois, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Tennessee, Virginia, Texas, and Washington), and others are offered by private colleges. The benefits of using a program like this are pretty clear.  The tuition is locked in at the price you paid for it, and the “gains” are reflected in the increasing cost of tuition of the years, and they accumulate tax-free.  So for example, if you started paying tuition in 2000, when a year of in-state tuition costed less than $7,000, and now (2019) the tuition is $14,000, you’ve essentially doubled the value of your investment.

But prepaid tuition plans also have some large downsides.  Firstly, they are tied to a specific state or private university, and it’s obviously impossible to predict the career trajectory and needs of your child years in advance.  Secondly, it’s very difficult to predict the rate of tuition increase of a particular state or school.  In most cases, the rate of return actually lags behind a reasonably well balanced portfolio of stocks and bonds.  Tuition prices are also often dependent on state legislative decisions, and the degree to which they want to subsidize higher education. So there is a significant element of political and legislative risk with choosing this option.  Finally, prepaid tuition programs don’t cover expenses outside of tuition (room and board, living expenses, books/supplies etc.), which can be a large portion of the costs incurred during a college career.

529 Plans

A 529 plan is a college savings program that varies state by state, and allows investors to accumulate an investment that can be withdrawn tax free for qualified education related expenses. The Oklahoma plan is available for all investors at Oklahoma 529. Contributions are still federally taxable in the year they are made, but Oklahoma has a provision to deduct up to 10,000 per year by an individual, or $20,000 if filing jointly. State deductions in Oklahoma may be carried forward as a deduction from income for the succeeding five years, subject to the annual maximum on deductions. This also means that the donor may qualify for a federal gift tax exclusion of $15,000 for individuals or $30,000 for married couples filing jointly.  The maximum 529 account balance for Oklahoma as of early 2019 is $300,000.

Recently, the Tax Cuts and Jobs Act added an extra benefit for 529 accounts.  The act added the ability to deduct K–12 private school tuition.  This obviously makes the investment choices more difficult, particularly if there are multiple beneficiaries with varying timelines for school attendance.

 One of the primary benefits over a prepaid tuition plans is that “qualified expenses” include tuition, room and board expenses, fees, and the cost of books, supplies, and both computer and software used by the beneficiary.  529 plans are also very easy to apply and include most post-secondary institutions.

Coverdell ESA Plans

A Coverdell plan is a tax advantaged education account similar to a 529 Savings Plan, with some important differences.  First, it is limited to individuals with annual adjusted gross income of less than $110,000, and couples filing jointly of less than $220,000.  Secondly, Coverdell contributions are limited to $2,000 per year for each beneficiary, so their ability to grow over time is significantly lower than in a 529.  Finally, there is no state tax deductions for the Coverdell, unlike the 529 which is deductible on Oklahoma state income tax.

The primary advantage of a Coverdell is that they can be withdrawn tax-free for a wide range of K-12 expenses, unlike a 529 which only can be used to pay for K-12 tuition.  This advantage is pretty important for families that send their children to private schools that have additional costs, like room and board, books, supplies, or uniforms.

The verdict?

At Arrow Investment Management, we are pretty big proponents of the 529 plan, unless your child is going to be attending private grade school.  In that case, it might be best to contribute $2,000 each year to a Coverdell, and then put excess contributions beyond that into a 529.