Back-to-School: How to Pay for College
Sleepless nights are an unfortunate reality when you become a parent. And nothing can get parents tossing and turning like thinking about how they will pay for their son or daughter’s college. For the very financially minded, this worry may arise as soon as you find out you’re expecting. Others may not start to worry until much later. No matter your child’s age, the staggering cost of college is likely to become a concern at some point. Consider this: a four-year education at a private college is on track to cost $323,900 by 2033. Might as well give up now, right? Wrong. You can build your child’s college fund slowly and steadily as you go from changing diapers to handing over the keys to the family car. The solution? A tax-deferred savings plan.
One of the most well-known college savings plans is the 529 savings plan. Aside from praying that you win the lottery or hoping your child becomes the next Mark Zuckerberg, 529 plans are a great way to incrementally save for college. Named after the section in the Internal Revenue Code, the 529 plan has been around since 1996. The government offers two types of 529 plans: college savings plans and prepaid tuition plans. With a college savings plan, you can use the funds at any college that’s accredited by the U.S. Department of Education. A prepaid tuition plan can only be used for undergraduate tuition at public colleges in your state.
529 plans offer some great benefits to whomever sets them up—parents, grandparents, or a generous aunt or uncle. Money saved can be used to pay for student tuition, any associated fees, textbooks, and room and board at accredited colleges and universities. Earnings in the 529 are not federally taxed, and generally not taxed at the state level when used for qualified education expenses of the designated beneficiary. And best of all, anyone can be named as a beneficiary — a son or daughter, a friend, even yourself. In Washington, DC, where Dan set up a DC College Savings Plan for his daughter, he can deduct up to $4,000 per year per plan ($8,000 total if he files jointly with his wife) on his DC return. In New York, where Lauren set up a plan for her son, she can deduct up to $5,000 per year on her state return (or $10,000 total if she files jointly with her husband). Unlike other investment plans (like Roth IRAs), 529 plans have no income restrictions on the contributor or the beneficiary. No limit exists to the number of plans you can set up, so have as many children as you want!
One note about 529 plans: If you already have one and your child will be attending school soon, be sure to request the money about two months before you need it to pay tuition, as it can take 4 to 6 weeks to get your money.
Coverdell Education Savings Account
A Coverdell Education Savings Account (ESA) is similar to a 529 plan, tax-wise, with a few exceptions. Unlike a 529, which must be used to pay for college to avoid penalties, a Coverdell ESA can be used for education at any level and can be used for school uniforms, books and school supplies. However, you can only contribute a maximum contribution of $2,000 annually per beneficiary in all accounts in the beneficiary’s name. Additionally, this type of account is only available to those whose modified gross adjusted income is less than $110,000 ($220,000 if filing jointly).
Education Savings Bond Program
Bonds have fallen out of favor in recent years, but don’t count them out as part of your arsenal of savings options for college. Unlike 529 plans, the money is guaranteed. Also unlike 529 plans, bonds do not have as much opportunity for growth, so, they probably shouldn’t be your only savings program. Having a portion of your savings portfolio in bonds can be a good way to minimize any fluctuations in the stock market when you are ready to pay for college.
Shop Around for Loans
If your child will be starting college soon and your college savings plan doesn’t cover the cost of tuition and fees, be sure to shop around for loans. Some parent loans for college can carry interest rates of more than 7 percent!
While the prospect of paying college tuition is daunting, you can find a number of ways to save. If your kids will be starting college in roughly 17 years, like our respective daughter and son, start now. Who knows what tuition will look like by then? And even if you’ve got a college savings plan in place, it never hurts to buy a lottery ticket now and again. Just in case.
Daniel Bond, CAE, Senior Communications Manager-Consumer Education, American Institute of CPAs.
Lauren J. Sternberg, Communications Manager-American Institute of CPAs.
529 pig courtesy of Shutterstock.