We’ll start with the good news: Tuition rates grew at a much slower pace in the past year. The bad news is that from 2003 to 2013, tuition rates rose nearly 80 percent, far outpacing average changes in household incomes. With these startling rate hikes, it’s not surprising that nearly 60 percent (or close to 12 million people) borrow money to attend college. Combined with rising student loan interest, the best method of paying for higher education is to begin saving long before your kids are even thinking about college. But we have advice for parents wherever they are along the continuum.
All 50 States
A 529 plan (named for its section number in the Internal Revenue Code) is a smart, lower-risk (this could vary depending on how you invest) method of saving for college. Granted, It’s also the most recommended account for college savings. The main advantage of 529 plans is that the money you invest grows tax free (federally), and often there are state tax benefits as well. You can open a 529 savings account with as little as $25 and individuals can deposit up to $14,000 a year without incurring a gift tax. Your 529 savings cover all “qualified higher education expenses,” including:
- Room and board
- Mandatory fees
- Books, computers (if required)
All 50 states offer 529 plans, but some offer either a prepaid tuition plan or a college savings plan. Some states offer both (to see what your state offers, click here). Anyone can open a 529 plan for a student (or beneficiary) – parents, grandparents, other relatives or friends, and the investment is transferrable (with some limits).
Prepaid plans, which are not as common, effectively allow you to purchase tuition credits at today’s rates. Savings plan investment sare based on market performance of your chosen stocks and bonds. Even for investment beginners, 529 plans are easy to choose from and understand. For more information on 529 plans, click here. There are, of course, other options to consider as well.
The primary, and often most attractive, difference between a Coverdell ESA (formerly called an Education IRA and recognized as a custodial/trust account) and a 529 plan is that the Coverdell ESA can be used to cover the tuition and education-related costs at primary and secondary schools. 529 plans are strictly for use at postsecondary and graduate schools.
The limit of contribution is $2,000/per year and the money you put into a Coverdell ESA must be spent by your child’s 30th birthday. If the funds aren’t used, they can be rolled over to another member of the family (who is under the age of 30). Another less attractive option is withdrawing the money, which is then subject to a 10 percent penalty and income taxes.
An alternative custodial trust you may consider is an UGMA (Uniform Gift to Minors Act) or an UTMA (Uniform Transfer to Minors Act) account. These accounts give parents control of contributions and withdrawals until the child reaches what’s called “the age of majority,” which is typically 18 or 21.
For more long-term planning, some families utilize Roth IRAs as a means to save for college. These contributions can be used for college expenses and any remaining funds can be saved for retirement. Roth IRAs differ from traditional IRAs in that contributions are post-tax.
For grandparents who want to help contribute to a child’s college education, the Roth IRA option is ideal, since account holders over age 59½ can withdraw their earnings and principal tax and penalty free. There are limitations for parents, however, and you should speak to a financial advisor about contribution limits and phase-out amounts, which vary depending on income and whether or not one or both parents are covered by a retirement plan at work.
Planning Ahead (For Everyone)
Any amount you can save to help out your student will help, but most financial experts would advise parents to consider their own retirement accounts first. As we’ve said before and it’s worth restating, there is no loan for retirement, which is why putting parents’ retirement (especially those amid their biggest earning years) smack dab in the middle of college savings advice is important! Why? Students have more options for borrowing money than do struggling retirees.
Scholarships, grants, part-time work in high school, financial aid, loans, and work-study programs are available to students. Here are some great online resources to help you get started when you’re deciding what and how to save for college:
- Academic and financial college preparation checklists for parents and students, starting from elementary age to adult learners.
- This Student Loan Calculator compares the average income associated with undergraduate majors to the cost of these programs.
- Use a Net Price Calculator to figure out the estimated cost of your university.
- Scholarship Finder is a great way to narrow down scholarships by eligibility requirements.
Remember, every dollar you and your child can save is money that won’t have to be repaid (with interest).
There are many ways to start saving for college tuition, but there’s more to school than that. Next week, we’ll break down student necessities like laptops and textbooks. For more advice on navigating financials or saving for higher ed, click here for friendly advice from the CommunityAmerica Credit Union Savin’ Mavens. This post was written by Maven Rance Carlson, vice president of CommunityAmerica Financial Solutions, LLC.