Early and Consistent Saving Is Key to Paying for College

If you have a child, or are even thinking about starting a family, you may be wondering how to afford to raise and educate your son or daughter with the cost of living ever increasing.

Thinking about financing an education for your children is the first step in securing their future. But act – don’t just think. Start a college savings plan right now, no matter the age of your children, or even if you are just in the family planning stage. The earlier you start, the better off you’ll be when it comes to paying for the astounding cost of college.

Tuition Shock

If you’ve done no research lately on the cost of a college education, it’s time for a reality check.

In its most recent survey of college pricing, the College Board reports a moderate college budget for an in-state public college for the 2017–2018 academic year averaged $25,290. Double that for a private college – $50,900 per year. The annual price tag includes tuition, fees, room and board, books and school supplies, transportation and personal expenses. The bottom line is college costs will increase steadily as your children make their way through elementary and high school.

But don’t despair! Fortunately, a number of approaches can help considerably, while not having to put the rest of your financial priorities on hold until your child starts college. Here are three options:

529 Tax-advantaged Savings Plan

Known legally as qualified tuition plans, these are sponsored by states, state agencies or educational institutions as authorized by Section 529 of the Internal Revenue Code. Funds in these programs are not taxed federally when used for qualified higher education expenses.

Most 529 Plans can be used to pay for college almost anywhere. You can be a resident of one state, invest in a plan in a different state and send your child to college in a third state or a foreign country. Nearly every state has at least one 529 Plan available. You can use this tool to check if specific U.S. and international colleges and institutions qualify for the plan.  

You can enroll in a 529 Plan directly through a plan manager. See The Best 529 Plans of 2018 to start your research. Or contact a trusted financial advisor to help you find a 529 Plan that suits your family and your financial needs and goals.

Prepaid Tuition Plan

Many – but not all – states offer pre-paid tuition plans for attending an in-state public school. So if you’re certain your child is heading for a state college or university, check to see if your state offers a plan that will allow you to pay for tuition credits at a predetermined price. These plans come with the same tax advantages of 529 Plans. Some states even offer a state tax deduction as part of the plan.

In many cases, the state assumes the market risk for the investor, basically guaranteeing your college investment. However, do careful homework and read the fine print in the contract before investing to see what particular conditions apply in your state.

The main risk of a prepaid tuition plan may be if your child decides to go to an out-of-state school or does not go to college. You may get a reimbursement, but you most likely will not get the full value of your plan returned.

And states also face the challenge of keeping up with the increasing costs of college. The plan’s investments may grow at a slower rate than the costs of college. Like the 529 Plans, the money you invest is earmarked for tuition. Funds used for other expenses will incur a 10 percent tax penalty.

Financial Gift to Minors

Two government rules allow parents or others to set up an account in their own name with a minor child as the beneficiary. These are the Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) accounts. The accounts enable a financial gift to the child and appoint a custodian of the account until the child reaches adult age. Such an account can be set up for the purpose of paying for college expenses.

These accounts come with tax advantages. For example, the first $1,000 in gains is tax-free; the second $1,000 is taxed at the child’s income tax rate, which is presumably lower than the adult custodian’s tax rate. Other tax advantages may apply, depending on the type of account.

When your minor child reaches the age of adulthood (18 or 21, depending on your state) the newly minted adult has complete control about how to spend the funds. That’s where the risk of this type of account enters. The person who set up the account (most likely you, or if you’re very lucky, a grandparent or generous aunt or uncle of your child) can’t transfer the money to another child or change the beneficiary, even if the new young adult decides to skip college and use the funds for another purpose entirely.

The other risk with this type of savings fund earmarked for college is that if your child applies for Federal Financial Aid, the money in the custodial account is considered an asset and is counted against them when the government rules on financial aid applications.

The Bottom Line for College Savings

There’s no absolutely perfect way to save for a child’s college education. The important thing is to start early and make regular deposits into the account. Savings earmarked for college – and never touched for other reasons – have a way of multiplying through the years. When it’s time to start paying out – a time that comes sooner than it seems possible – at least a big chunk of the needed college funds will be there.

 

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