Ouachita Stories

Chris Brune, Ph.D., CFP® is a professor of finance in the Hickingbotham School of Business, where he also serves as chair of the Department of Accounting and Finance and sponsors the Ary Student Investment Fund, managing millions of the university’s endowment. We recently sat down with Dr. Brune to hear his thoughts on questions that parents are asking — and what questions they should be asking about financial planning for college.

While you're here, learn more about Ouachita scholarships or look at free budget worksheet provided by Dr. Brune.

Part 1 | Part 2

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Once you know why you’re saving, the next question is where the money should go. Dr. Brune walks through the main options. 

Q: A family has decided to save. How should they choose where the money actually goes? 
A: It helps to separate two decisions people sometimes blend together. The first involves selecting the type of account, which can be influenced by your tax situation, eligibility for financial aid and desired level of control over the assets. The second decision involves the selection of investment products held within the account. Some accounts offer more options than others, and it’s important to match your investments to your personal situation.

Q: What is a 529 plan, and why do you most families look there first? 
A: A 529 is a tax-advantaged account designed specifically for education savings, and for most families it’s a good starting point. Several features make it a preferred option. 

In a 529 plan, contributions are made with pre-tax dollars and money grows tax deferred. When it’s time to pay for college, you can pull money out tax free as long as it’s used for qualified education expenses. 

It’s also more flexible than people expect. If your student earns a scholarship and doesn’t need the full account balance, you can reassign the remaining balance to another family member — a sibling, or even yourself, for later education. Recent changes in the law broaden the definition of “qualified education expenses” to make more expenses eligible and let you redirect unused 529 funds into a Roth IRA for the student (limits apply). Unlike other account types, there is no federal limit on how much you can contribute, although federal gift tax rules may apply to annual contributions. 

QUICK DEFINITION: TAX-DEFERRED
You don’t pay taxes on the account’s investment growth year to year while it compounds. In a 529 used for qualified education costs, you never pay tax on that growth at all — unlike a regular savings or brokerage account, where gains can be taxed along the way. 

Q: When would a different account make more sense than a 529?
A: A Coverdell education savings account provides similar tax benefits but with a much wider range of investment choices than most 529 plans. The trade-off is the contribution limit, which is $2,000 a year. They also have income limits that make them inaccessible to some families.

Q: What about custodial accounts?
A: Custodial accounts also offer a variety of investment options, but without the contribution limit. The downside is that they don’t offer the same tax advantages as a 529 or Coverdell account. However, the biggest difference with a custodial account is that it can be used for any type of expense that benefits the child and not just education expenses. The tradeoff? Once the child reaches the age of majority, the money legally becomes theirs to use however they choose.

QUICK DEFINITION: AGE OF MAJORITY
The age — set by each state, usually 18 or 21 — when a young adult gains full legal control of assets in their name. With a custodial account, the balance becomes theirs to spend at that point, college or not.

Q: Once the money’s in an account, how should a family think about investing it?
A: Match the investments to your timeline and risk tolerance. The more years you have before your student starts school, the more risk you can generally afford to take. With 10 or 15 years to go, you may choose to invest more heavily in stocks because you have some time to ride out the ups and downs of the market. As the timeline shortens, it’s usually wise to shift your focus to preservation instead of growth and gradually pull back on risk.

QUICK DEFINITION: RISK CAPACITY VS. RISK TOLERANCE
Risk capacity is how much risk your timeline and finances can objectively absorb. Risk tolerance is how much uncertainty you’re personally comfortable with. If your tolerance is lower than your capacity, that’s fine — it just means you’ll need to save more to reach your goal. 

Coming soon in part 3: what to do when you’re starting early, and why a small amount now can matter more than a larger amount later. 

 

• Tags:
• College Planning