Table of Contents
“Training is everything. The peach was once a bitter almond; cauliflower is nothing but cabbage with a college education.” Mark Twain
“If you think education is expensive, try ignorance.” Derek Bok
“College is part of an American dream. It shouldn’t be part of a financial nightmare for families.” Senator Barbara Mikulski
How early can you start saving for your child’s college education?
Planning for your children’s financial future should begin as early as their birth. Actually, I did set up a 529 plan before we had children. I intended to go to law school and I wanted a 529 savings plan to help pay for escalating tuition fees for three years. Our first child coincided with my first year of school and I ended up changing the beneficiary to my son. I set up a second 529 plan soon after my daughter arrived.
While technically you can’t have a 529 college savings for an unborn child because you need a social security number, you can set it up in the parent’s name and change beneficiaries later on. It makes tremendous sense to take advantage of as long a timeframe as possible using the benefits of compounding growth. The House tax plan in 2017 tried unsuccessfully to expand eligibility to include unborn children as long as “the unborn child is in utero.”
The more you begin saving today, the less you need to borrow later on. There are imposed federal student loan limits, the more affordable borrowing source, as compared to private loans. Your best bet, if your child’s education is a priority as I am sure it is or will be, is to adopt a saving strategy.
The cost of a college education
Average annual college tuition rates over a ten year period between 2008-2009 and 2018-2019 rose 2.3% for private nonprofit four year colleges and 3.1% public four year colleges according to The College Board. Average tuition, fees, room and board published prices are $48,510 for private nonprofit four year colleges, $21,370 for public four year in-state colleges and $37,430 for public four year out-of-state colleges. College tuition prices rise with inflation and other costs offset by continued political pressures to provide reduced or free tuition. I would not count on that ever becoming a reality.
There are several ways to save for your children’s college education and reduce borrowing that you or your child will need to do for college later on. By contributing early and often to these accounts, you may avoid the need to face the prospect of borrowing for your child’s college tuition, fees, room and board, or at least ease a substantial part of the burden.
Funding your children’s tuition well ahead of their needs allows for compounding benefits while enhancing your tax situation. There are differences in offerings by age, income, and contribution limits, flexibility to make changes, investment opportunities, and tax implications. Make sure to speak to your accountant or tax professional regarding the tax issues.
Six ways to save for your child’s college education and take advantage of some income tax breaks are:
- 529 College Savings Plans
- A 529 plan is a college savings plan that offers tax-deferred savings and financial aid benefits.
- Originally begun to save for college, the plans may now be used to save and invest for K-12 tuition at private schools, retaining their tax-deferred nature. The Tax Reform Act in 2017 expanded 529’s ability to include $10,000 per year for K-12 tuition. Under the Act, the $10,000 withdrawals per year are federally tax-free. State tax treatment of these withdrawals differs from state-to-state. So check with your state’s taxing authority or state 529 plan administrator. For example, Connecticut’s 529 plan allows you to withdraw tax-free for up to $10,000 per child to be used for private school tuition.
- Virtually every state has a 529 plan and you do not have to live in that state to set up an account in each child’s name. Each state plan may vary so check what works for you.
- There are no maximum caps as to how much money can be invested per year.
- Parents can typically choose among a range of investment portfolio options which may include Vanguard mutual funds, exchange-traded funds (ETFs), static or fixed allocation fund portfolios, and age-based portfolios sometimes called target-date portfolios. Which fund you choose depends on your appetite for control and risk. You can make changes between the funds based on your children’s age or the target date portfolios which shift from more aggressive growth rates to more conservative rates as your child ages.
- The amounts can be used for any eligible higher education, not just four year colleges or universities including vocational and trade schools; community colleges and graduate schools.
- 529 plans typically do not have income or age limits. An older person can use it for school later on.
2. Coverdell Education Savings Account (ESAs)
- These accounts are similar to 529 plans offering tax-free investment growth and tax free withdrawals when funds are spent on qualified education expenses. Like 529 plans the invested amounts are not limited to college and can be used not only for K-12 tuition but also expenses, including books. At one time Coverdell ESAs were the sole tax-advantaged way.
- Unlike 529 plans, contributions made to Coverdell ESAs are limited to $2000 annually per beneficiary similar to limits set for IRAs .This means grandparents can each set up their own account for the same beneficiary with a $2,000 limit for each account.
- A Coverdell investment option is self-directed. It is not pigeon-holed into the state’s specific options like 529 investment track options.
- Coverdell ESA’s have age and income limits. A beneficiary must use the funds by age 30 unless the beneficiary is a special needs person. If your adjusted gross income is over $220,000 as a married couple or $110,000 as a single taxpayer, you cannot contribute any longer.
- While Coverdell ESA’s give you greater investment flexibility than 529 plans, the imposition of limits have caused some to consider rolling their Coverdell ESAs into 529 plans.
3. Custodial accounts: Uniform Gifts to Minors Act (UGMA) or Uniform Transfers Minor Act (UTMA)
- Custodial accounts can be set up for each child if they are under the age of 14 years and managed by the parent until the child turns the age of majority, typically age 18 years unless stated otherwise.
- Investments in these accounts are not limited.
- For children below 18, the first $1,050 of unearned income from the investment is tax-free to the child, after which the next $1,050 is taxed at the child’s tax rate, then income above the $2,100 is taxed at the parents’ (usually higher) tax rate. When the child turns 18, they will be paying taxes at their own rate.
- Couples filing jointly can contribute up to $26,000 annually for each child, or $13,000 if an individual is setting up an account. Anyone can set up a custodial account, including grandparents, aunts and uncles.
- Once the child has access to the account based on their age of majority, it is their asset. The invested money may be used for anything that child wants, including frivolous things which unfortunately the parents have little power in reclaiming that asset.
- These type of accounts are typically for supplemental spending for college, and not likely to go to tuition.
4. Traditional IRAs
- Traditional IRAs, typically used for retirement savings, would normally incur a 10% penalty for withdrawals before age 59.5 years.
- There is an exception if an individual wanted to use this account for qualified college expenses for themselves, child or grandchild and they would not be penalized for early withdrawals. Frankly, retirement accounts should never be tapped for college tuition.
- Since you cannot borrow for retirement, but you can for college, parents or a child would be better off to take out a loan for college.
5. Invest in discount bonds
- Another way to save for college costs, is to invest in deep discount corporate, US government (Treasury) or municipal deep discount bonds. These bonds are often referred to zero coupon bonds because its owners are not collecting coupons twice a year.
- These bonds come in maturities of one year-40 years and do not pay semi-annual dividends like regular bonds. However, the IRS requires that you pay tax on the interest portion annually.
- Check with your tax professional about the possible tax implications of zero coupon municipal bonds and tax treatment in the years before redemption given that interest income from municipal bonds have favored federal tax treatment and sometimes state preeemption unlike corporate and treasury bonds.
- Treasury bonds have triple AAA ratings so they are considered virtually risk-free while ratings of municipal bonds and corporate bonds vary.
- You can redeem the bonds at full face value upon their maturity. The proceeds of these bonds can be used for college costs.
- Deep discount bonds are not just used to save for college tuition but their long term nature are suitable for planning for your children’s non-tuition college needs as all.
6. Series EE Savings Bonds
- Savings bonds are sold by the federal government for half their value or $5,000 for maturity denominations of up to $10,000.
- Like treasury bonds, they are safe based on their triple A rating.
- Usually savings bonds are taxed at the federal level and tax-exempt on state and local levels but if you are using these savings bonds for college tuition expenses than they are typically tax-exempt at the federal level as well.
It is never too early to start saving for your children’s future, especially for a college education.
Tuition costs are high but far more bearable if you save early. The more you save, the less you need to borrow on that day your child gets into college. Keep in mind that there are federal loan limits and private loans are more expensive. As I mentioned earlier, you can set up a 529 plan for yourself or for an unborn child and change the beneficiary once you have their social security number. It is exercising prudence on behalf of your child’s financial future. The alternative to not saving is the hardship you may encounter when applying for college loans and need to decide whether you as the parent or your children will take on the debt or some combination. Lessen your burden as early as you can.
Have you looked into 529 plans or alternatives to begin saving? Are you doing something different to save and like to share? We are interested in hearing from you!
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.