Ways
to Save for College
Comparing
& contrasting the potential of some popular vehicles.
Provided by Jared Daniel
How expensive will college be tomorrow? The Department of Education projects that by 2030, the tuition
cost of obtaining a four-year degree at a public university will surpass
$200,000. Staggering? Indeed, but college is plenty expensive already. In 2012,
tuition averaged $15,100 a year at public colleges and $32,900 a year at
private colleges.1
A
Sallie Mae study finds that today’s students, on average, can only pay for 24%
of their college expenses. It is little wonder that student loan debt exceeds
credit card debt today.1
How can you start saving to meet those costs today? With interest rates being what they are, don’t look to a
garden-variety savings account. Even if current interest rates soon ascend to
2% or 3%, you would be at a disadvantage even if the bank account was large as
tuition costs are climbing more significantly than inflation.
The
message is pretty clear: to meet college costs, you need either a prepaid
tuition plan or a savings vehicle that taps into the power of equity investing.
Let’s look at some options.
Prepaid 529 plans. Offered by
states and public colleges, these plans let you buy tomorrow’s tuition with
today's dollars. You purchase X dollars of tuition today, and that is guaranteed
to pay for an equivalent amount of tuition in the future.
You
can do this in two different ways. Some of these prepaid plans are unit plans,
in which you pay for X number of college credits or units now with a promise
that the same amount of credits will be covered in the future. In other words,
you’re locking in tuition at current rates.
As
an example, let’s say a year of college at Hypothetical State University
requires 36 units. Mom and Dad use a unit plan to pay $7,500 for those 36 units
now for their 6-year-old daughter. In turn, the plan promises to pay whatever
those 36 units cost when she starts her first semester at Hypothetical State 12
years from now, even though it might be much more.2
The
other prepaid 529 plan variant is the contract plan, or guaranteed interest
plan. In these prepaid plans, you make a lump sum contribution (or arrange
recurring contributions), essentially buying X number of years of tuition. In
turn, the plan guarantees to cover this predetermined amount of tuition
expenses in the future.2
Usually,
beneficiaries of prepaid tuition plans must be residents of the state offering the
plan, or prospective students of the college offering the plan. In the wake of
the recession, some of these plans are not accepting new investors as some
states are worried about underfunding.2,3
529
college savings plans. These state savings plans allow you to invest to build
college savings rather than simply prepay them. Plan contributions are
typically allocated among funds, and possibly other investment classes; the
plan’s earnings grow without being taxed. The withdrawals aren’t taxed by the
IRS either, as long they pay for qualified education expenses.2
You can contribute up to
six-figure sums to these 529 plans – there’s a lifetime contribution limit that
varies per state. Most of them are open
to out-of-state residents. If the market does well, you can harness the power
of equity investing through these plans and potentially make a big dent in
college costs.2
There are two caveats about 529 plans. Should you elect to withdraw money from a 529 plan and use it for
non-approved purposes, that money will be taxed by the IRS as regular income –
and you will pay a penalty equal to 10% of the withdrawal amount. 529 balances
can also negatively affect a student’s chances for need-based financial aid. In
a given school year, that eligibility can be reduced by up 5.64% of your
college savings.3
Coverdell
ESAs. Originally called Education IRAs, Coverdell Education Savings
Accounts offer families some added flexibility: the withdrawals may be used to
pay for elementary and secondary school
expenses, not just college costs. These are tax-deferred investment accounts,
like 529 savings plans. Unfortunately, the current annual contribution limit
for a Coverdell is $2,000. Any remaining account balance must generally be
withdrawn within 30 days after the beneficiary’s 30th birthday, with the
earnings portion of the balance being taxable.3,4,5
Roth
IRAs. Yes, it is possible to use a Roth IRA as a college savings
vehicle. While the IRA’s earnings will be taxed, withdrawals used to pay for
qualified college expenses will not be taxed and will face no IRS penalty.
Additionally, if your son or daughter doesn’t go to college or comes into some
kind of windfall that pays for everything, you end up with a retirement
account. While Roth IRA balances don’t whittle away at a student’s chances to
get need-based financial aid, the withdrawal amounts do come under the category
of untaxed income on the FAFSA.3
Life
insurance. Some households look into so-called “cash-rich” life insurance –
whole or universal life policies – as a means to fund a college education. This
requires a big head start, as when you buy one of these policies the bulk of
your premiums go toward the life insurance part of the contract for several
years and you have yet to build up much cash value. The big feature here is
that most colleges don’t consider life insurance when evaluating financial aid
applications.3
Would
a trust be worth the expense? Rarely, families set up tax-advantaged
trusts for the purpose of college savings. In the classic model, the family is
incredibly wealthy and the kids are “trust-fund babies” bound for elite and
very expensive schools. Unless you have many children or your family is looking
at potentially exorbitant college costs, a trust is probably overdoing it. The
college savings vehicles mentioned above may help you save for education
expenses just as effectively, all without the administrative bother associated
with trusts and the costs of trust creation.
Jared Daniel may be reached
at (480) 987-9951 or Jared.Daniel@WealthGuardianGroup.com.
This material was prepared by MarketingLibrary.Net Inc., and does
not necessarily represent the views of the presenting party, nor their
affiliates. All information is believed to be from reliable sources; however we
make no representation as to its completeness or accuracy. Please note -
investing involves risk, and past performance is no guarantee of future
results. The publisher is not engaged in rendering legal, accounting or other
professional services. If assistance is needed, the reader is advised to engage
the services of a competent professional. This information should not be
construed as investment, tax or legal advice and may not be relied on for the
purpose of avoiding any Federal tax penalty. This is neither a solicitation nor
recommendation to purchase or sell any investment or insurance product or
service, and should not be relied upon as such. All indices are unmanaged and
are not illustrative of any particular investment.
Citations.
1 – money.usnews.com/money/blogs/my-money/2012/07/25/how-much-will-you-need-to-send-your-child-to-college-in-2030
[7/25/12]
2 – www.axa-equitable.com/plan/education/529-plans/529-vs-prepaid-tuition.html
[2011]
3 – money.cnn.com/101/college-101/savings-plan.moneymag/index.html
[1/10/13]
4 – money.msn.com/tax-tips/post.aspx?post=9dba01a0-b233-4e6e-97ef-aecbc62188e3
[1/9/13]
5 – www.irs.gov/uac/Coverdell-Education-Savings-Accounts [9/11/12]
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