How do we save for college?
Parents want the best for their children, which often includes a college education. Some new graduates leave campus with a diploma in one hand and a huge student loan bill in the other. Parents want their graduates to leave school with minimal debt.
There are about as many answers as there are families. Below are a few common ways to help save and pay for college, and the pluses and minuses of each to help make informed decisions.
Whatever you choose, remember that by saving today, you give your money the most time to grow before school bills arrive.
College Savings Plans
College savings plans are opened and administered to a beneficiary (usually a child) by an account holder (usually a parent) who directs the investments. Investment options may include money market funds as well as stock and bond mutual funds. Some have age-based portfolios that shift money between types of investments, becoming more conservative as the beneficiary approaches college age. College savings plans, along with prepaid tuition plans, are a type of “529 Plan”—named for Section 529 of the Tax Code, which created those plans.
Pluses: Investment earnings are tax-deferred, and withdrawals are tax-free, if used at more than 7,000 schools in the United States and abroad for qualified education spending (such as tuition, mandatory fees, room and board, and required books and computers); No residency requirements; Year-round enrollment; No age limits (adults returning to school can benefit).
Minuses: No lock on college costs; Investments are not guaranteed (funds may lose value).
Prepaid Tuition Plans
Prepaid tuition plans lock in costs at today’s prices at participating colleges and universities. Costs often include tuition, mandatory fees, and sometimes room & board. While these are usually state-sponsored programs for schools in the state’s college system, some private colleges and universities also offer prepaid tuition plans. Most plans require an initial lump-sum investment, plus regular installment payments based on the age of beneficiary when the account is created and the number of years of college purchased. Prepaid tuition plans are a type of “529 Plan”—named for the same Section 529 in the Tax Code that created 529 college savings plans.
Pluses: Locks many college costs at today’s rates; State governments often guarantee the investments.
Minuses: May have residency requirements; School choices may be limited; Most plans have a limited enrollment period; Most plans have age/grade limits for beneficiaries.
Coverdell Education Savings Accounts
Coverdell Education Savings Accounts or ESAs, sometimes called “education IRAs,” are similar to college savings 529 Plans. Available to families with a modified adjusted gross income of less than $110,000 ($220,000 if filing jointly), they differ from 529 Plans in that they also can be used for private elementary and secondary school as well as college expenses. Coverdell ESAs enable families to save—within contribution limits—with taxes deferred on the investments, and tax-free withdrawals, if used for eligible educational expenses. Existing Coverdell ESAs can be rolled into a 529 Plan, as funding a 529 Plan is considered a qualified education expense.
Pluses: Can be used for private elementary and secondary school as well as college; Investment earnings are tax-deferred; Withdrawals are tax-free, if used for qualified education spending; Investment options are almost unlimited; Can be established at many financial institutions including brokerage firms and mutual-fund companies.
Minuses: Annual contribution limited to $2,000 per year per beneficiary – total from all sources, for example $1,000 from the parent(s) and $500 each from two grandparents; Income limits make some families ineligible.
The Uniform gifts to Minors Act
The Uniform Gifts to Minors Act and the Uniform Transfer to Minors Act allow assets such as stocks, bonds, real estate, and even fine art to a child. Sometimes known as UGMA and UTMA, these accounts are administered by the gift giver or an appointed custodian until the child reaches adulthood (age 18 or 21, depending on the state). The assets become the child’s property and can be used to help pay for college.
Pluses: Investment income is taxed at the child’s (usually lower) tax rate.
Minuses: Not offered in every state; Since the transferred assets belong to the child, their value may affect financial aid eligibility.
Those are the most common ways available to most families to save and pay for college. When you decide which is the best for your family’s situation, remember that time is one of the best ways to have your money grow. The sooner you start saving, the more time the money will have to grow, and the less your family will need to borrow for college.
America Saves Week (Feb. 26-March 3, 2018) is an excellent time to think about—and start—saving for college. As Invite Education always says: “Saving a dollar today is better than borrowing one tomorrow.”
By Invite Education staff