THINGS TO CONSIDER WHEN PLANNING FINANCIALLY FOR COLLEGE
As many people know, earning college grants and scholarships can be difficult – there is a great deal of competition, and even students who get excellent grades are denied. Unfortunately, it can also be difficult to obtain student loans – even though that money must be paid back with interest.
Funding your kids’ college expenses is certainly not as straightforward as you might think. Still, despite all the hurdles and difficulties, numerous opportunities exist that you can take advantage of by being creative and planning carefully.
The Rising Cost of Tuition
College tuition in the United States is expensive – and if you haven’t been paying attention, you may be in for a shock. According to a College Board report, students at four-year private colleges have the most expensive total cost of attendance. Factoring in tuition, fees, and room and board, the average “sticker price” for the 2011-2012 school year was a whopping $38,589, while in-state students at public four-year institutions paid an average of more than $17,000. The costs for out-of-state students at public four-year schools fell in between, with an average of $29,657.
College costs are rising faster than the rate of inflation. Over the past five years, tuition prices have risen an average of 5.6%, while inflation’s annual rise has been just under 3%. Predicting these costs is not a perfect science, but by most estimates, a four-year
education at a private school will cost an average of more than $200,000 by 2016.
Start With a 529 College Savings Plan
If you plan to save for at least part of your children’s education, a 529 college savings plan is the best place to start. 529 plans are popular because you can invest money for college on a tax-advantaged basis. As long as the funds are used for qualified expenses, such as tuition, room, and board, you don’t need to pay taxes on the earnings when you withdraw them. You also won’t pay federal taxes (and, in most cases, state taxes) on any gains the account accrues while it is invested.
Furthermore, many states offer other benefits for investing in that state’s 529 plan, such as state income tax deductions on contributions, as well as matching grants. Keep in mind, you may only be eligible for these benefits if you participate in a 529 plan sponsored by your state of residence, so make sure you check your state’s tax code before investing.
Investing in a 529
Set up a 529 as a custodial account – the account is in your name, which means you own it, but your child is named as the beneficiary. Start by determining a target dollar amount for your child’s college costs; then, estimate a realistic rate of return and invest accordingly. Use an online college cost calculator to help figure out the amount of money you need to reach your goal. Since money in a 529 must be used for college expenses, take care in running these numbers to get as accurate an estimation as possible.
What you don’t want to do is invest too much. If you need to withdraw funds for non-college expenses, you will be faced with a stiff 10% penalty in addition to the ordinary income tax on the earnings withdrawn. However, you can change the beneficiary so another child or relative can make use of excess funds. That said, a better strategy to avoid “coming up short” or over-investing is to complement a 529 savings plan with other investment vehicles that function well for college expenses.
Other Investment Vehicles
In addition to 529s, several other types of investment products can effectively help you save, and may offer additional ancillary benefits.
1. Roth IRAs
Roth IRAs are retirement accounts similar to a traditional IRA or a 401k, but unlike those accounts, you can withdraw contributions you’ve made to a Roth for any purpose without penalty. Additionally, you can withdraw earnings without incurring the 10% early withdrawal penalty if the funds are used for qualified education expenses. You will, however, have to pay tax on those earnings if you choose to withdraw more than the total of all your contributions.
2. Permanent Life Insurance
Permanent life insurance, like whole life insurance and universal life insurance, are plans in which there is an insurance component (the death benefit) and a cash component that can be partially withdrawn or borrowed against. Also, as an added perk, the cash value in a permanent life policy does not count as a liquid asset when colleges determine how much financial aid your child qualifies for.
When you borrow against your cash value, you don’t owe tax. However, you do have to pay interest on the loan. Borrowing against the investment component of the policy is a way to receive a portion of the investment (growth included) tax-free. On the other hand, if you make a withdrawal, you will owe tax on the earnings. You can set up these policies so that your heirs receive the death benefit plus the remaining cash value after you die – or, you can set them up so your beneficiaries receive the death benefit minus how much you borrowed from the policy.
Because permanent life insurance policies are varied and fairly complex, review your options carefully. It’s best not to invest in permanent life insurance for the savings component unless you have a legitimate life insurance need (and since you have one or more children, it’s likely that you do have a need).
Also, life insurance policies are not liquid investments – most have a surrender period during which time you pay a penalty to access your funds. Make sure you fully understand the ramifications of borrowing or withdrawing from a life insurance account before tapping into it to pay for college.
3. Fixed Annuities
Fixed annuities are a type of retirement account from which you can make withdrawals during retirement or receive a guaranteed income stream. Because money in a fixed annuity counts as retirement savings, colleges can’t look at it when determining how much financial aid you qualify for. However, the IRS charges a stiff penalty for early withdrawals. Furthermore, the annuity company levies a surrender charge if the annuity is substantially tapped during the surrender period, which is often the first five to seven years.
However, if you’re at least 59 1/2 years of age while your child is attending college, an annuity account could be an ideal way to save as long as it’s out of the surrender period by the time you need to tap it. But if you aren’t 59 1/2, an annuity is likely a very poor savings vehicle for anything other than your retirement.
When it comes to paying for college, having a plan and sticking to it is the best way to go. Talk with your kids early on about what they should expect from mom and dad regarding assistance in paying for college. Speak to a qualified financial planner if necessary to better understand the ramifications of your choices, and find suitable investments.
Though having student debt can help your children appreciate the value of education and the sacrifices parents make, planning for and preparing for that debt is just as important. Of course, if your kids qualify for aid and college scholarships– that’s even better. But it’s not something to hinge your college savings plan on.
Start a college fund: 8 strategies.
1. SECTION 529 PLANS.
A Section 529 plan is a tax-advantaged investment plan, issued and operated by a state or educational institution, which helps families save for college. Section 529 plans1 are named after the tax code that governs them. Almost all 50 states offer these plans, and rules vary by state. In many cases, you don’t have to be a state resident to take advantage of them; in fact, you can invest in multiple 529 plans in multiple states, if desired.
2. COVERDELL EDUCATION SAVINGS ACCOUNTS.
With Coverdell Education Savings Accounts (formerly known as Educational IRAs), you can make contributions for each child, until he or she is 18.
3. UNIFORM TRANSFERS TO MINORS ACT (UTMA) AND THE UNIFORM GIFTS TO MINORS ACT (UGMA).
These custodial accounts allow you to set up an account in the child’s name. You can make transfers to a UTMA/UGMA account on a per-child, per-year basis. Check the IRS website for current contribution limits. Check with your tax advisor, prior to making any decisions.
These days, most people borrow at least a portion of the money needed to cover college expenses. You may want your children to look for student loans with special rates and repayment terms. For details on these options, check out the U.S. Department of Education’s site at www.ed.gov.
You can invest money in an account earmarked for your child’s education costs. Generally, it is better to invest when the child is young (less than five years old).
The US Department of Education has the following Student Financial Assistance Programs:
Tax credits are better than tax deductions, as you subtract the credit from your total taxes due. Check the IRS website for the current tax credit amounts, and for more details regarding credits.
8. FINANCIAL AID.
There are billions of dollars available each year in scholarships, grants, and work-study programs. Financial aid to middle income families may be tough to come by, but some universities may be more willing to offer generous financial aid packages.
There are thousands of financial aid programs available. They fall into three general categories:
Federal, state and campus-based grants. (Grants are free money generally offered on a financial-need basis.)
Student loan programs (from special rate guarantees to special repayment schedules).
"Special situation" scholarships (given for achievement without regard to income or assets).
It’s certainly worth contacting your child’s high school and prospective college financial aid office to see if you’re eligible.
Your role in providing financial support to pay for your children's college education is crucial. Life insurance can help assure that, if you die and, as a result, your income is lost, your children's dreams of a college education need not be lost as well.