Presently it is nearly impossible for young people to be competitive in the job market without having at the very least a bachelor’s degree from a respectable university. This is not helped by the fact that over the last 35 years, average tuition and total higher education fees have risen by approximately 1200%. It is not written in stone that over the next 10 to 20 years education fees will continue to rise at such an aggressive annual rate, but it would be prudent to assume that costs will at least increase in line with inflation, and as such nearly double again by the time a child born this year arrives at graduation day.
Accordingly, it is not surprising that a goal-oriented planning exercise we help clients undertake is to determine how much higher education fees may cost in total, and what type of savings and investment strategy best achieves the savings target to safely cover all the associated costs.
The first step in the exercise is likely to be the more complex and personalized aspect of the planning process. The total expected financial requirements for higher education depend largely on the current or expected size of the family, what level of education the parents are targeting for their children, how many years of post-secondary education with which they expect to assist and in what country they expect their children to study. As such, working this out typically requires some personal reflection on the part of the parents, as well as some guidance and input from an experienced advisor that has been through this exercise with numerous other families.
The second step in the planning process, determining the appropriate investment strategy, is rather straightforward. After determining a reasonable savings target for the children’s total university costs, you are then able to think about how best to reach these goals. Because it is not possible to push university back if your investments don’t work out, most parents tend to err on the side of more low-risk, liquid, and structured investment strategies. This is in contrast to, for example, retirement planning whereby most people are more comfortable taking calculated risks. With retirement, the goals are typically further off in the future than university fees and, for example, if the market is experiencing a short downswing during the expected retirement date, it can always be pushed back, or retirement income scaled back for a short period of time until things improve. However, education is more set in stone. It is not difficult to determine that, for example, you will require $350,000 starting exactly 15 years from today. As such, you should match your predictable liabilities with predictable assets.
Education Fees Planning for US Citizens in Japan
If you are an American citizen, you may have heard of the so-called “529 Plans”. 529s are a great way to save for education fees in a way that is both flexible and tax efficient. If you are familiar with Roth IRAs, think of a 529 as a Roth IRA for education; meaning you contribute to the account with after-tax dollars, and then all growth on investments within the account is free of all state and federal taxation. Also, in order to invest into a 529 account, your savings will need to be transferred out of Japan and back to the US to be domiciled in an approved account in America. As such, it would likely also be a good idea to discuss with a knowledgeable professional about the best way to transfer money from Japan. Lastly, like any other investment strategy, there are a few drawbacks to the 529.
Advantages to the 529 Savings Plan:
- Tax free growth on investments within the account
- Investment Flexibility and Control – You can invest in normal market based investment funds, or guaranteed products from local or state governments
- Flexibility for contributions and distributions – ANY person can contribute to a 529 plan for the benefit of ANY other individual. (for example, grandma and grandpa can easily contribute to their grandchild’s education plan. Or for example, if you don’t currently have a family of your own, you can easily contribute to an account for the benefit of a friend or family member’s children)
- Currently 32 states offer an extra tax benefit – You may be able to deduct contributions to a 529 plan from your annual income taxes. However, while living in Japan this benefit may be rare, as you would need to be receiving taxable income in the United States, and have a form of residence in a participating state.
- Beneficiaries of the 529 plan can be changed to family, even yourself – For example, if your kids end up getting a scholarship and do not need help with tuition, you can easily switch the beneficiary to another family member, or even yourself. “Why change the beneficiary to myself?” you may ask; for example, some retirees are looking into interesting “semester at sea” type qualified education programs whereby pensioners study and learn about interesting new subjects while traveling around to interesting new places.
- Investments within the 529 plan can be looked after by professional money managers with many options, freeing you up to focus on other priorities.
Disadvantages to the 529 Savings Plan:
- If you use distributions for the plan for anything other than qualified education expenses (tuition, books and supplies, reasonable room and board) then you will have to pay Income Tax (not long term capital gains tax) on investment gains in the account, as well as an additional 10% tax penalty. In other words, do not contribute too much into the 529 account, because it could then get rather costly if you end up not using the savings for education.
- You will be responsible for keeping track of all receipts and documentation to evidence all relevant qualified education expenses in order to receive the full tax benefits on distributions.
- There could be some restrictions as to how many changes to your investments you are able to make per year (ie. the government does not want you to use your 529 account as a day-trading account).
Education Fees Planning for Non-US Citizens in Japan
If you are looking into savings and investment options for education fees, and you are not able to make use of the 529 plans, there are still a world of options available to you. In fact, there are even someguaranteed return structured savings products that are only available to non-US citizens like yourself. Predictability and stability rather than the potential for above-market returns are perceived by many to be a fair trade-off when it comes to education fee planning. As mentioned, the focus for this type of strategy should typically revolve around reduced risk, reduced volatility and high liquidity.
There have been numerous occasions where when faced with the prospect of expensive education costs, we have heard a client suggest “oh, well we could always sell this or that property to pay for university…” While this is true, it would be highly impracticable, as real estate is illiquid and experiences some of the longest market cycles. In other words, on the exact year your child turns 18, your property may be experiencing a down-cycle in market value with no end in sight, and it could also be uncertain how long it could take for you to sell the property and receive the cash. As such, it is a popular strategy to separate education fee planning from other investments. This allows for much greater flexibility and control over your savings.