When I was in high school, it was never a question of “if I go to college” it was a question of “what college will I attend”. My parents encouraged me to apply for scholarships, which helped fund an in-state university tuition of $12,000. That was twenty-something years ago – how things have changed.
Over the past 30 years, the cost of attending college has risen an average of 7% a year, exceeding that of inflation. For a child born today, that will equate to a bill of perhaps up to $350,000 to fund four years at a private university. Parents are faced with the dual responsibility of planning for retirement and financing their child’s education. With many of the tax loopholes used in the past now closed, new strategies must be found to save for this important– and crucial– part of your child’s life.
The most popular strategy available today is the 529 Plan. This is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans back in 1996. In 2006, Congress made the tax-free treatment of withdrawals used for educational expenses a permanent feature, and the funds in a 529 plans can be used for all educational expenses including books, room, board, tuition and miscellaneous fees. Every state now has at least one 529 plan available and the plans do vary from state to state. Some states, but not all, offer tax incentives to investors as well.
There are two types of 529 plan, or as they are legally known as “qualified tuition programs”. There is the pre-paid tuition plan and the college savings plan.
Pre-paid tuition plans generally allow college savers to purchase units or credits at participating colleges and universities for future tuition and, in some cases, room and board. Most prepaid tuition plans are sponsored by state governments and have residency requirements. Many state governments guarantee investments in pre-paid tuition plans that they sponsor.
College savings plans generally permit a college saver to establish an account for a student for the purpose of paying the student’s eligible college expenses. An account holder may typically choose among several investment options for his or her contributions, which the college savings plan invests on behalf of the account holder. Investment options often include stock mutual funds, bond mutual funds, and money market funds, as well as, age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age. Withdrawals from college savings plans can generally be used at any college or university. Investments in college savings plans that invest in mutual funds are not guaranteed by state governments and are not federally insured.
Another savings strategy is called a Coverdell Education Savings Account, or ESA. These accounts are similar to 529′s in that they are tax-deferred and tax-free when the money is withdrawn for approved educational expenses, which includes tuition for any sort of schooling (including elementary level). The main difference is contributions are much more limited at $2000, and there are income limitations for contributors (although anybody can contribute who meets the income requirements, not just relatives). The account must be depleted when the beneficiary turns 30, or there will be a 10% penalty and the gains will be taxed.
Traditional and Roth IRAs are another good tool for financing education, as money can be withdrawn for educational purposes without incurring the ten percent penalty. An even better option is having the child fund an IRA in his or her own name, assuming they have some earned income to contribute, and then they have the option to used some of these funds for educational expenses as necessary.
Purchase Zero-coupon Bonds. These are bonds that pay all their interest at maturity as opposed to providing a regular interest income stream over time. The advantage is that the bonds may be purchased for a substantial discount compared to their face value at maturation.
Open custodial accounts such as UTMAs and UGMAs. Less popular than they have been in the past due to closing of “kidde tax” loopholes, these custodial accounts are tools that allow children to have ownership of assets without the creation of a trust.
In Summary: For those folks with children, integrating a plan for saving for college education into your overall financial life plan has become more crucial than ever before. Education is a necessity in today’s society for success, and the costs for obtaining this necessity are skyrocketing. With some advance planning, diligence and committment, you can provide your child with a gift that may make the difference between a fulfilling life– or just a life.
