5 Ways To Save for College

Providing a college education is one of the most common goals we hear from clients. As the flight attendant always says, “Please put your mask on before assisting others.” The best thing you can do to help your children is get your own finances on track. Once you have a grasp on your plan, there are 5 specific ways you can save for your child’s college education.

529 Accounts

529 accounts are the most common form of savings for children’s education and they are sponsored at the state level. You can also use an Advisor to set one up but it rarely adds value and it’s an unnecessary fee to pay.

How it works

Anyone with a social security number can have a 529. A 529 will be set up in a specific state and can be transferred to another state if needed. Once an account is setup, generally you can contribute up to $16,000 a year into each account. For example, if you have 3 children you can contribute $16,000 into each account or $48,000 total. There is a special provision that allows you to advance up to 5 years into an account, which would allow you to put $80,000 into an account in a single year but that would prevent you from contributing for the following four years.

The good news:

• As the investment grows, there is no tax on distributions if it is spent on qualified education expenses.
• The beneficiary of the account can use the money to attend any university, technical school, master program, or professional program
• Money can also be used to help pay for k-12 education
• Some states offer instate tuition at public universities if they hold your account, even if you move out of the state
• If the beneficiary does not need or use the money in the account, it can be transferred to another person
• The beneficiary does not hold the account, parents and guardians can maintain control and distributions
• 529s are inexpensive to setup and charge very little to maintain
• A 529 will not affect a student’s ability to apply for need based aide in most states

The bad news:

• Contributions have no federal tax benefit. Some states have contribution tax benefits where you contribution can be deducted against your state income taxes up to a limit.
• If you cash out or withdraw for non-qualified education expenses, your earnings will be charged a 10% penalty and income tax on the growth.
• College tuition or the need/desire for most to go to college may change in the future and if you save a significant amount into these accounts, you’ll may be frustrated (we know we would be).

How much do I need to save?

There are some great tools to help you predict how much you need to save. A conservative rule of thumb is that a $100 a month from 0-18 will provide 1 year of a public in-state education expense for a student. The earlier you start, the easier it is to achieve your goals.

How do I do it?

The best and most cost-effective way to setup a 529 is through your state administration plan. You don’t have to use your state’s plan though, you can use any state’s plan but if there is a state income tax deduction on your contribution, then it is best to use your state’s plan.

How is it invested?

If you choose, you can use a target date fund (like you may be using for your retirement) for your 529 that will change allocation depending on the age of the student and the estimated start for their education. If your child is young, the investments profile should be more aggressive but will become more balanced over time.

Prepaid Tuition

Prepaid tuition is a unique option where some states allow parents to pay for their child’s future education at today’s rates to protect against rising costs.

The good news:

• The amount is fixed regardless of how much tuition changes over time. What you pay guarantees the education, even if the cost goes up 10 times over the next 10 years.
• You avoid any market swings and do not have to deal with any of the stress of investing.

The bad news:

• Can only prepay for tuition, not room and board or other expenses.
• Lack of flexibility causes increased risk for loss of investment
• Only available in certain states and at certain universities

How do I do it?

If your state is eligible, it will be offered as an option on the state 529 plan or you can check here for a list of last states who offer this.

Roth IRA

Depending on your financial plan, using your Roth IRA to fund your child’s education could be an option. Although a Roth is a retirement account, any of your contributions can be taken out if the account has been open for 5 years. You can also access the growth for a child’s education without a 10% penalty but you will pay income taxes on this portion.

This gives parents the flexibility to help without locking in the inflexibility associated with a 529. It is important to note that a Roth IRA can be an important part of your retirement portfolio and using a portion of your contributions should be carefully considered.

Custodial Account

A custodial account can be another way to pay for children’s education. This is like a normal brokerage or after-tax investment account. The benefit is that the dividend/income tax each year would go against your child’s income which will likely be much lower than yours, thus reducing the tax burden. The downside is that at 18, the child takes control of the account, and the parents or guardians have no control of where the money goes.

Takeaway

Being able to give your children a head start financially towards further education is a gift but each strategy has positives and negatives that can be important to consider. Be sure to think through how you imagine higher education changing, the likelihood of your child going to it and if you want to have any additional flexibility in the vehicle you choose.

Disclaimer: This post is for informational purposes only and is never to be taken as advice or a recommendation. Talk to a tax or legal professional to determine how this information best applies to your personal situation.