Meet the Expert
Katie Plato developed a deep love for education when she worked with special needs students during her high school career. She has enjoyed working in the field of education ever since. Katie earned an interdisciplinary degree in education and psychology with an emphasis in reading development. She is interested in various educational methods and philosophies, especially child literacy, educational psychology, autism and special education. Drawing from a liberal-arts education and worldview she enjoys researching various aspects of university life from architecture to athletics. She also loves collaborating with her husband on research projects when they aren't chasing their five children or working on their little one-acre farm.
The cost of college is rising, and rising fast. With an over 1,000 percent increase since 1978, and now a common news item, college tuition is becoming difficult for many Americans. It is estimated that the average cost for incoming freshman in the school year 2016-17 attending a four-year public university will be $30,000, and attending a four-year elite university will be $71,500. By the end of this student’s career, they will have spent over $120,000 and $286,000 respectively. Few families have this much money to spend on one child, let alone several children, and expecting students to cover the cost of education with debt only slows their start in life. There are scholarships, financial aide, and other resources available to help cover the cost of education, but the fact remains that families will still need to contribute a significant amount to their child’s education.
Why Aren’t Parents Saving for College?
Here are some common reasons parents aren’t saving for college:
- They can’t afford to
- They are counting on scholarships
- They are counting on student loans
- The cost is high and it is too overwhelming to start
- It is more important to save for other things
- Other family members and friends will help pay for college
- My kids aren’t going to college
- My parents didn’t save for me, and I went to college
- I already have enough money saved for college
Introduction to College Savings Plans
Looking at these sobering statistics can be overwhelming, especially if parents haven’t started saving, and have multiple children. Thankfully, there are a lot of savings options that can be started with a minimal amount of money and little effort. Even saving a small amount is better than nothing, especially with some of the account options available, your money can grow to build a future for your child.
Compare College Savings Plans
The following offers an overview of some of the most common types of college savings plans.
College Savings 529 Plans:
- 529 plans were created by section 529 of the Internal Revenue Code. A 529 savings plan is a qualified tuition program, sponsored by a state or state agency, designed to allow families a tax-advantaged way to save for college.
- A 529 college savings account provides federal tax advantages, potential state tax benefits, account control, and investment flexibility.
- Savings can be used at eligible institutions for tuition, fees, books, supplies, and equipment required for enrollment. Room and board is also a qualified education expense if the student is enrolled at least half-time.
- Contributions can vary and are only limited by the maximum and minimum contribution limits set by most plans. Although the maximum contribution amount differs from state to state, in the majority of states offering college savings plans, the maximum amount that you can contribute for one beneficiary exceeds $250,000.
529 Prepaid Tuition Plans
- You pay for amounts of tuition (years, credits or units) in one lump sum or through installment payments.
- There are a number of options. Some prepaid tuition plans offer contracts for a two-year community college or a four-year undergraduate program, or a combination of the two, and can cover one to five years of tuition. Some plans even allow the contract to be applied to graduate school tuition.
- With only a few exceptions, most prepaid tuition plans do not cover other expenses, such as room and board.
- Prepaid tuition plans have no investment options. Under prepaid plans, the price of the contract is determined prior to purchase and usually depends on the type of contract, the current grade of the beneficiary, the current and projected cost of tuition, and the projected rate of return.
- When a child is ready to go to college, the plan transfers funds to cover the tuition directly to the institution.
Coverdell Education Savings Account
- A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses.
- The total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary must be under age 18 or be an individual with special needs.
- Contributions to a Coverdell ESA are not tax-deductible, but amounts deposited in the account grow tax-free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.
- The benefit applies to qualified higher education expenses as well as to qualified elementary and secondary education expenses.
- There are contribution limits for taxpayers based on the contributor’s modified adjusted gross income.
- The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are custodial accounts that allows parents to save for their child’s education or other purposes that benefit the child.
- Typically you cannot use the funds for items such as food, housing, clothing, or other parental obligations.
- A custodial account is used to hold and protect assets for a minor until the age of majority is reached. As a custodial account the assets are held in the child’s name with an individual serving as custodian. They are irrevocable gifts to the minor. When the beneficiary attains the age of majority, the beneficiary gains control and can use the funds for any purpose.
- UGMA and UTMA accounts are taxed at the child’s or the parent’s tax rate, depending on the amount of taxable income each year.
- The principal portion can be withdrawn tax-free and penalty-free at any time for any purpose.
- Earnings in the account grow tax-free and can be withdrawn tax-free and penalty-free only after you reach retirement age.
- Diistributions are not taxed as earnings until the entire principle balance is withdrawn. That means you can take out as much as you put in tax-free to pay for college and withdraw the earnings portion tax-free when you turn 59 1/2.
- Married couples filing jointly with a Modified Adjusted Gross Income (MAGI) of $183,000 or less ($116,000 or less for individuals) can contribute the maximum amount of $5,500 to a Roth IRA for 2015. Couples with an MAGI greater than $193,000 ($131,000 for individuals) are ineligible for a Roth IRA.
- Retirement accounts are not considered assets on the Free Application for Federal Student Aid (FAFSA), which means the value of your Roth IRA won’t hurt your chances for financial aid eligibility. However, when you take out money from your Roth to pay for college it will be counted as student income on the following year’s FAFSA.
- Mutual funds are an investment that allows a group of investors to pool their money and hire a portfolio manager. The manager invests this money—the fund’s assets—in stocks, bonds, or other investment securities. The fund manager then continues to buy and sell stocks and securities according to the style dictated by the fund’s prospectus.
- Among the many types and styles of mutual funds are stock funds, bond funds, sector funds, money market funds, and balanced funds.
- Mutual funds allow you to invest in the market whether you believe in active portfolio management (actively managed funds) or you prefer to buy a segment of the market with no interference from a manager (passive funds and index funds).
- The availability of different types of funds allows you to build a diversified portfolio at low cost and without much difficulty.
- Mutual funds offer a simple, efficient way to invest for retirement, education, or other financial goals.
- U.S. Savings Bonds are fully guaranteed, making them a safe way to save for college, they offer a low-risk and modest-return investment for college saving.
- As long as the bonds are used to pay for qualified college expenses, the interest earned is generally free of federal, state, and local taxes. If purchased early in the student's life, they provide a safe, guaranteed return once college rolls around.
- Bond buyers must be at least 24 years old. Parents can purchase bonds for their children, but the bonds must be registered in the parent's name.
- The bond buyers must not exceed annual income limits. A married coupled filing jointly can take the full tax exclusion if their income is below $113,950 and take a partial exclusion if their income is between $113,950 and $143,950.
- The funds must be used for qualified educational expenses for parent or dependent child. These include tuition and fees for courses that count toward a degree or certificate program. Books and room and board are not qualified expenses.
- Both the principal and the interest from the bonds are used.
- You can transfer eligible EE and Series I bonds to a 529 account or ESA with no penalty.
One of the best ways to save for college expenses is through a 529 Plan. Some benefits of a 529 are:
- 529 Plans are tax-advantaged accounts designed specifically for paying for college.
- You can choose any 529 Plan from any state, and they can be used at almost any college or university all over the country.
- There are federal tax benefits, as well as tax benefits in over half of the states.
- Withdrawals are tax-free as long as they are being used for college expenses.
- 529 Plans accrue interest.
- Each state offers financial advisors to help you decide and manage your 529 account at a low cost.
- Many plans offer automatic withdrawal, and allow for small monthly contributions.
- You can contribute as much as you want per year.
- Grandparents, friends, relatives, and anyone else can contribute the account.
How a 529 Plan Works:
A 529 plan is a tax-advantaged savings plan designed to help parents save for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. There are two types of 529 plans: pre-paid tuition plans and college savings plans. Investing in a 529 plan may offer college savers special tax benefits. Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for eligible college expenses, such as tuition and room and board.
Federal and Estate Planning Tax Benefits of a 529 Plan:
- They offer tax-deferred growth, and any earnings can grow faster than a taxable account.
- Tax-free distributions for certain qualified expenses including tuition, fees, books, supplies, on-and off-campus room and board and certain expenses for special needs students.
- You can contribute up to $70,000 (or $140,000 if married and filing jointly) to a 529 plan immediately and average the contribution equally over a five-year period without incurring a federal gift tax.
Top 10 Tips to Save for College
Start saving early.
The earlier parents or guardians start to save, the better. Even if the amount is small, every little bit counts. Interest will build over the years, and parents will start to see return on their investments.
Start saving on a regular basis.
Many of the 529 accounts available only require a minimum monthly contribution of $25. Set up a monthly automatic withdrawal for the minimum amount, and over the course of 5 years, that money will have grown with little effect on the pocketbook.
Research the options.
Spend some time looking into the options available in your state, as well as all of the different college savings accounts and plans available. Decide what works best for your financial situation, choose one, and stick with it.
Fill out a FAFSA.
When it comes time to send your student to college, be sure to fill out a FAFSA. You may be surprised at the Expected Family Contribution, as well as the amount of financial aide your student will receive.
Research various scholarships.
Is your student scientifically minded? Do they spend their summers working at summer camps with underprivileged kids? There are hundreds of scholarships out there for high school and college-bound students. The internet is a wealth of information. Search out every scholarship that may apply to your student and apply. Even little amounts add up quickly and can help cut the cost of college.
Evaluate options yearly.
The Higher Education Act, which controls most federal student aid programs, is up for reauthorization periodically over the years. Lawmakers are always making changes to college funding plans, and colleges change their requirements. Stay up to date, monies that may not have been available one year may be available the next.
Consider Community College.
If your son or daughter isn’t sure what degree they want to pursue in college it may be worth it to complete general credits at the local community college and transfer into a 4-year school once the general credits are completed. This can save a significant amount of money and still work towards completing a college degree.
Consider college credits while in high school.
Many high schools offers college credit for classes already being taken. Check with your high school counselor to see if your student can double up and receive college credits for a class. The credits will cost, but it will be a fraction of the cost of completing it later.
Learn about education-related tax credits and deductions. These include the Hope Scholarship and Lifetime Learning credits, and deductions for tuition, fees, and student loan interest. If you qualify, these are great opportunities to reduce your tax bill if you're paying for your college education or that of a dependent.
Don’t get discouraged.
Looking at the cost of college can be overwhelming and discouraging, especially if you have multiple children. There are many options and programs available to help families pay for college. With the right planning, research, and careful saving, college dreams can become a reality.