That new baby (or grandbaby) coos and smiles and melts your heart. It’s hard to imagine her all grown up and heading off to college. Before you know it, she’ll be walking across that stage getting her high school diploma and buying decorations for her dorm room. How will you pay for her college dream? That’s a question many parents don’t have an answer for, but we’ve got some tips for you to consider today that will help you pay for college later.
Set a goal and start as early as possible
Just like saving for retirement, the earlier you start, the better – preferably the day that baby is born. Get those investments in place and let them grow, even it’s a small amount each month. According to the College Board, the average annual in-state college tuition for a public, four-year college in 2016-17 was $9,650 ($23,930 out-of-state). At an annual increase of 5% – 8% per year, in-state tuition for a baby born today could be over $83,000 for the four years of college. That doesn’t factor in living expenses like room and board, either. Clearly, the first step is to come up with a reasonable savings goal. Check out the U. S. Department of Education’s net price calculator tool to estimate your costs. Then, you can choose from several options for saving enough for college.
College Savings Options
There are some great investment instruments for college savings – a 529 account, a Coverdell ESA, a Uniform Gift to Minor Account, and general savings accounts or CDs. The Sallie Mae website has a simple chart that compares these four types of college savings plans. Roth IRAs may also be considered. You can use one or a combination of these accounts to meet your college savings goal..
The 529 Plan
About 40% of families are currently using a 529 plan to save for college. Established in 1996, this is an educational savings account operated by a state or educational institution, named for Section 529 of the IRS code. Earnings are federal (and often state) tax-free as long as the money is used for qualified educational expenses. Gift tax rules apply to 529 contributions.
To get the most bang for your buck with a 529 plan, start it when your child is young and ask relatives to contribute to it (as birthday or holidays gifts). Be sure you shop around for the best plan with the lowest fees. Some states offer residents a tax break or lower fees, but you do not have to buy a plan in the state where you reside. Buy direct. Brokers will charge fees to manage your 529 account, cutting into your returns on investment.
A Coverdell Educational Savings Account is similar to a 529 but is limited to an annual contribution of $2000. That might make it hard to reach your goal of covering all or most of your child’s college costs. The cool thing about the Coverdell is that it can be used for K-12 education expenses as well as for college.
Uniform Gift to Minor Account
This type of account can be used for anything, not just education. Like a 529, there are higher contribution limits. Once your child (the beneficiary) turns 18 or 21 (depending on the state) she has complete control over how the money gets spent. If she decides not to go to college, but wants to spend the money on a car or a trip, she can.
General Savings Accounts
Most families are still using a general savings account to save for college expenses. When my son went off to college in 2005, he had a Bright Futures Scholarship that paid for 100% of his tuition, so our savings account covered his room and board and other miscellaneous expenses. General savings accounts are great, but you don’t get the tax breaks or the returns that you get when using a 529 or Coverdell account.
Tax-free distributions make Roth IRAs a popular investment tool. You can open a Roth IRA in your child’s name as soon as she begins to earn some income (baby-sitting money, part-time job). The problem here is that you have to wait until your child is older to start saving and that may be too late to cover college costs.
Prepaid tuition plan
Some states offer a prepaid tuition plan. This is an option if you are certain your child will go to an in-state, public university or college. It locks in tuition at current (or nearly so) rates. That savings can offset fee hikes and inflation when your child enters college. But if your girl decides she wants to go to an out-of-state or private college, you will lose the benefit of locking in tuition at the lower rate. Fewer states are offering prepaid tuition plans since the 529 account has become so popular.
What about scholarships?
Scholarships and grants can help offset college costs and don’t have to be paid back like loans. Scholarships are offered for many things in addition to academic achievement and athletics, including for certain majors, for minorities, for women, for community service, and unusual things like left-handedness and creativity. Really! The U. S. Department of Labor has a fantastic tool for searching for scholarships. Beware of scholarship scams. You should never, ever have to pay to apply for a scholarship.
Often, the university where your child applies will offer scholarships specific to the school. Be sure to check with the school’s financial aid office to find out what is available. My son received a surprise scholarship offer, that he had not applied for, along with his acceptance letter from one college. That offer was a factor when he made his final college choice. (See more tips from us on Financial Aid.)
Ask your accountant
Saving for college can impact your taxes. When your child goes to college, how she uses her scholarships, loans, and college savings accounts may also have an impact your taxes. Likewise, her eligibility for aid will be impacted by your assets and her own income. These college years can be get complicated.
So, be sure to check with your accountant as well as the college financial aid office if you need help sorting it all out. At Team Holly CPA, we’re here to help.