Funding your kid’s college education may be one of the largest financial investments you’ll encounter in your lifetime- and it’s not getting any easier, as tuition continues to rise about 6% every year. Understanding how to manage college savings wisely will allow you to save thousands of dollars, and maintain control over the increasing costs.
While budgeting may be overwhelming, it’s important not to loose sight of the value of higher education. While the tuition, room and board at a 4 year private college is about $27,000 per year, the benefits of a Bachelor’s degree greatly outweigh the costs. According to the U.S. census bureau, a college graduate in 2005 will earn about 70% more than someone with only a high school diploma.
That said, there are basically 6 ways to begin saving for college.
- Section 529 Prepaid Tuition Plans
- Section 529 Savings Plans
- Coverdell Education Savings Accounts
- UTMA/UGMA Accounts
- Save in Parents’ Name
- Save in a Child’s Trust
With the ever increasing costs of college, this plan is very beneficial to parents with younger children who will not be attending college for quite some time. It allows you to lock-in current tuition rates, which increase in value over time. For example, a family can purchase shares for a full year of tuition at a public 4 year university, and these shares will always be worth a full year’s tuition- no matter the percentage of increase over time. If the student decides to attend a private or out of state college, the state will cover the amount of in state public tuition at that time, and you are responsible for the difference.
There are added benefits to the locked-in tuition rate. Prepaid tuition plans are exempt from Federal income tax, and often from state and local taxes as well. Family members and friends can also contribute to the tuition plan, allowing them to contribute to the student’s education. The downside to the 529 Prepaid Tuition Plan is that it decreases the amount of need-based financial aid by 100%, meaning that for every dollar saved on the plan, a dollar of need based aid is subtracted.
While this plan can provide peace of mind, and a convenient, tax-exempt way for parents to save for college, this is not the best option for everyone. Benefits are greatest for middle to high income families, who do not qualify for need-based aid.
For more information on the Section 529 Prepaid Tuition Plan, visit IRS Publication 970.
The 529 Savings Plan, while more “risky” than the 529 Prepaid Tuition Plan, is much more flexible in terms of which colleges the student can attend and which school expenses it will cover. This tax-exempt plan also has a low impact on need-based financial aid. There are a few downsides to this plan, including the limited investment choices, higher account manager fees (about 1-2%), and no guarantee that the shares won’t lose value in a declining stock market.
This plan can be compared to a retirement 401K. However, the 529 Savings Plan has much higher contribution limits, and a more favorable tax rate.
The Coverdell Education Savings Account, formerly the Education IRA, is designed for the benefit of a child under the age of 18, and contributions to the account will not be accepted after the students 18th birthday. While there are some income guidelines, anyone can contribute to this savings account- as long as it doesn’t exceed $2,000 per year.
While the per-year savings limit is rather low, it is tax deferred and may be withdrawn tax-free if all savings is being used toward educational expenses. For more information on the Coverdell Education Savings Account, go to http://www.irs.gov/.
The Uniform Transfer/Gift to Minors Act Account is a custodial account set up in your child’s name, and therefore accrues less taxes than a regular savings account set up under your own name. By law, all of the money put into the UTMA/UGMA Account is an irrevocable gift to your child, and therefore he/she has full rights to all of the funds after trust termination (18-21 years depending on the circumstances).
Each contributor can add up to $10,000 dollars per year to the account, while still avoiding gift taxes. However, not even the custodian can place any regulations on how the funds are spent once the UTMA or UGMA terminates.
Go to http://www.statefarm.com/ for more information.
Unless you are sure your child won’t qualify for need-based aid, do not save under his/her name. While savings may be taxed at a lower rate under the child’s name, there are many more risks associated with doing so- including the child not being obligated to spend the money on education, and a reduction of financial aid if the money is transferred into another account.
After the age of 14, funds from a parent’s account can be placed under the child’s name, and therefore be taxed at a lower rate. However, transferring funds back into the parents name afterward is not an option, and this greatly reduces the amount of financial aid the student will receive, due to the fact that need-based analysis assumes the child is contributing much more of his/her income and assets than the parents. In most cases, the money saved on transferring savings into a child’s name, does not outweigh the effects it has on financial aid.
Try not to be overwhelmed by the many funding options you have available to you. There is a lot of information out there, on the internet especially, that can help you make an education decision. As long as you research each option carefully, you are sure to find one that best suits your family.