Students and families in the U.S. now owe more than $1.7 trillion in student loan debt, making this the second highest consumer debt category, trailing only mortgage debt. Student loan debt is now higher than both credit card and auto loan debt.
The best way to avoid racking up a lot of student loan debt, of course, is to save enough money to send your kids to college debt-free. Fortunately, there are several different savings tools available to help you accomplish this goal.
Section 529 Plans
529 plans remain the best college savings vehicle for many families. Earnings grow on a tax-deferred basis while distributions are tax-free if they’re used to pay for qualified education expenses. This definition is broad and includes college tuition and fees, room and board, books, supplies, and personal technology (like computers and printers).
These plans are offered by states but you can choose a plan outside of the state where you live. Your child doesn’t have to go to school in the state where you choose a plan, either. Here’s a good resource for browsing each state’s 529 plan.
There are two main types of 529 plans. With a prepaid tuition plan, you can buy future tuition at current prices, which provides some certainty when it comes to your college costs. By purchasing four years of college for a young child today, you could possibly save tens of thousands of dollars in tuition.
An investment savings plan is similar to a retirement savings account like an IRA or 401(k). You can invest your savings in the market to try to maximize returns and your account balance will fluctuate based on your investment performance. There is risk involved with this strategy, but if you have a long-term time horizon, the risk might be justified.
Coverdell Education Savings Accounts (ESAs) were originally called Education IRAs. As with 529 plans, contributions made to Coverdell ESAs grow on a tax-deferred basis and distributions are tax-free if the money is used for qualified education expenses. However, you can’t continue to fund the account once your child turns 18. And any money left over after graduation must be distributed to your child.
While the contribution limit is relatively low — just $2,000 per year — Coverdell ESAs can be useful as a supplemental college savings account. For example, you could contribute the first $2,000 of your college savings each year to a Coverdell ESA and then make all remaining contributions to a 529 plan.
Sometimes referred to as UTMAs (Uniform Transfers to Minors Act) and UGMAs (Uniform Gifts to Minors Act), these accounts are set up by parents and grandparents for the financial benefit of their children and grandchildren. They aren’t designed specifically for college savings but can be used for this purpose.
Custodial accounts don’t offer tax-deferred growth or tax-free withdrawals, but they do provide another tax benefit: Account earnings are initially. taxed at your child’s rate, which is probably lower than your marginal tax rate. Beyond a certain level, however, income is taxed at the parents’ rate due to an IRS rule popularly known as the kiddie tax. You should be aware of this rule if you’re planning on accruing a large sum in a custodial account to fund college.
Finally, custodial account funds don’t have to be used to pay for college expenses like 529 and Coverdell ESA funds do. This could prove beneficial if your child decides not to attend college or receives a scholarship, but you should also bear in mind that once your child reaches the age of majority, he or she will have unfettered access to the funds.
Taking the Community College Route
One cost-saving strategy that’s being adopted by many families nowadays is to send their child to a community college for a year or two before transferring to a flagship college. The average cost of tuition and fees at a four-year public college is $10,560 for in-state students and $27,020 for out-of-state students, according to the College Board. This soars to $37,650 for four-year private colleges.
At community colleges, the average annual cost of tuition and fees drops to just $3,340 for in-state students and $8,210 for out-of-state students, according to Educationdata.org. If your child can live at home and attend a local community college, you’ll save even more. Often, the same core classes are taught during the first two years at community and flagship colleges, so your child may not miss out on anything academically.
How Does College Fit within Your Financial Plan?
If you’re reading this post, you’re likely aware of the advice to fund retirement first and then fund college. While that advice is sound, it brings with it a whole host of questions from how you know if you’re saving enough for retirement, how much you should be saving for college and how to handle any shortfall when it comes to funding college.
As part of a comprehensive plan, we help address all of those questions, from long-term planning to keep you on track for retirement to identifying aid and scholarships available for the particular colleges your child is considering. If you’d like to learn more about how we can help, send us an e-mail or schedule an introductory call.