What Are the Best Ways to Save For College As a parent how do you choose a savings vehicle that provides the best financial aid benefits, tax advantages, and flexibility while meeting your overall investment needs. This decision will affect your child’s future more than just about any other financial decision that is made for them.
It is the difference between entering the work-force with all the tools needed and being debt free or having to struggle through the job market with the elephant in the room known as college debt. The following is designed to help you educate yourself on the options available. What is the ideal goal of saving for college? For most is would mean using the best means possible of investing money so that the principal is not at risk, has guaranteed growth, is tax advantaged and is a form of leaving a legacy both financially and in the form of an educated child that is prepared for their future. Cd’s and Money Market Accounts According to a recent Gallup poll released by Sallie Mae- 59% of people surveyed said they are using Cd’s of money markets to save for college for their child.
This is a safe way to save and will grow your money. The disadvantages are the fact that most earnings will not keep up with inflation and secondly the growth will be taxed at the current tax rate at the federal level. The funds are not protected from creditors. 529 plans: State Savings Plans A 529 plan is a state savings plan governed under Section 529 of the Internal Revenue Code. There are two types of 529 plans 1) state savings plans and 2) prepaid tuition plans.
They are very different vehicles for college savings. A state savings plan lets you save money for college in an individual investment account. Some plans are managed by a financial professional, while others allow you to enroll directly. You contribute money to the account as often as you wish up to the plans limits. Your contributions fund the investment portfolios you’ve chosen, which are typically mutual funds. The financial institution the state has designated is solely responsible for managing the portfolios.
You have no control how these portfolios are run. The contributions grow tax deferred, so you don’t pay income tax on the accounts earnings each year. When it comes time for your child to go to college you with draw the funds to pay for college and it is tax free at a federal level. The funds can be used at any college that is accredited by the U.S. Department of Education. The funds can be transferred to a sibling or other qualified family member without penalty. State saving plans have their drawbacks too.
If the funds are not used for college you will owe the income tax and a 10% penalty on the earnings portion of the withdrawal. You relinquish control of your money. Returns are not guaranteed; you may gain or lose money. There are typically fees to maintain the account based on a percentage of the total account value. The funds are not typically protected from creditors. Each 529 plan has its own set of rules and restrictions, which are subject to change. Make sure to request the most recent plan details from plan administrators.
In addition, for more information on the tax benefits and consequences of 529 plans, consult IRS Publication 970 529 Plans: Prepaid Tuition Plans A prepaid tuition plan is a tax-advantaged college savings vehicle that lets you prepay tuition expenses now for use in the future. The plans are either run by the state or the college. State run plans allow you to go to one or more of the state run colleges. College run plans allow you to prepay the tuition at the given college.
The purchase of credits is done periodically or in lump sums depending on the plan limits and rules. Usually the tuition credits are guaranteed to be worth a certain amount of tuition in the future, no matter how much college costs increase. Your contributions grow tax deferred so you don’t pay income tax each year. The qualified withdraw for college is tax free at a federal level. Prepaid tuition plans have their draw backs too. If you don’t use the money for college you will pay income tax and a 10% penalty on the earnings portion of the withdrawal. Your child is limited to participating colleges- if your child chooses to attend a different school plans differ on how much money you will get back. Money in prepaid plans is treated less favorably than money in a state savings plan for purposes of federal financial aid.
Once again there are fees to open and maintain the account. In addition, for more information on the tax benefits and consequences of 529 plans, consult IRS Publication 970 Coverdell Education Savings Accounts This account is unique in the fact that it allows you to save for elementary, secondary and college. The maximum contribution is $2000 even if the money comes from different people. The funds can be used to pay for tuition tax free at the federal level. Coverdell plans have their draw backs too. If the funds are withdrawn for a non-qualified reason you will pay the income tax and the 10% penalty on the earnings portion of the withdrawal.
The funds that are not used will be distributed to the child when she reaches the age of 30. In order to qualify for the Coverdell education savings account you must have a modified adjusted gross income of $95,000 or less and joint filers must have a modified adjusted gross income of $190,000 or less. Roth and Traditional IRA’s Typically used as a retirement account but it does allow you to use it as a college savings vehicle in which your funds have tax-deferred growth and withdrawals are tax free for education.
There is a large variety of ways for you to invest in IRA’s which gives you flexibility in your ability to handle risk. Investing in your own retirement account allows you to control the money and if your child decides to choose an alternative path to college you have the ability to let the money continue to grow towards your personal retirement. Any investment earnings in your Roth IRA are also available for withdrawal without the ten percent penalty, but subject to regular income tax. You may withdraw investment earnings tax-free if you’re over 59 1/2 and you’ve had your Roth IRA for at least five years. This is beneficial if your child chooses not to go to college are another need for funds arises. IRA’s do have their disadvantages too.
There is no guarantee of return and no guarantee that the principal will not be lost due to a down turn in the market. There is an income cap and restrictions on the amount you are able to contribute. UGMA & UTMA Custodial Accounts The Uniform Gift to Minors Act (UGMA) established a way for minors to own securities.
The Uniform Transfer to Minors Act (UTMA) is similar, but it allows minors to also own other types of property and for transfers to occur through inheritance. UTMA is slightly more flexible than UGMA. These types of accounts allow a donor to make an irrevocable give to a minor and once the minor reaches the age of maturity the funds become theirs. The custodian has fiduciary responsibility to manage the funds for the benefit of the minor. Custodial Accounts have their disadvantages too.
Neither the donor nor the custodian can place any restrictions on the money once the minor becomes an adult. The funds are not transferable to another beneficiary. Not everyone has a person that has the ability to give a gift to the minor for college costs. Infinite Banking Concept While this is not a concept that many people are familiar with it is a strong tool to use in funding your child’s college tuition.
The wealthy have used this tool to fund a variety of projects from major appliance purchase, cars, homes and businesses. The options are many. The infinite banking concept is a dividend paying whole life insurance policy that has the flexibility to work as a long and short term method to fund college tuition and act as a retirement vehicle.
Life insurance used as a college savings plan serves all types of income earners, grows tax deferred, protects against risk, has no limits to the amount of contribution, has no restrictions on the use of the funds, has no pre-determined time that these funds need to be withdrawn and does not have any bearing on the financial aid the student may qualify for. The funds are protected from litigation and creditors. The fund while building cash value in order to save for college will provide insurability for the minor and will provide a death benefit if the unthinkable were to happen.
Once the child has graduated college the child will have an established banking system in which he can repay the college debt and finance all future purchases. The infinite banking concept doe have its disadvantages too. Not all people are disciplined enough to establish the vehicle in order to reap the long term benefits. Summary: Please review the table that is attached to this document. Cd’s and Money markets are a sure fire way to save for college. The majority of the population chooses to use these vehicles. The down side is the growth rate is slow and you may not keep up with inflation costs.
So while it is a convenient method it may end up not growing fast enough to be the strongest way to invest for college tuition 529 Plans offer a way to save for college and off-set inflation by potential growth or in the pre-paid tuition plans buying actual credits so it doesn’t matter how much the credits cost in the future you locked in at an earlier time. The biggest risk seems to lie in the fact that you are giving up control of your money, your state may not invest wisely and when your child is ready to go to college the fund may have been diminished, 2007 and 2008 would be good examples of parents having to scramble to find the extra funds for their children’s education.
The additional problem lies in the fact that most of these plans are state specific and if you are forced to move to a different state or your child decides the want to go to a school not in the state you may face losses, whether it be having to pay out of state tuition or if they decide not to go the penalties associated with using the money as a non-qualified use typically income tax and a 10% penalty.
Coverdell Education Savings Accounts are useful in the fact that the funds grow tax deferred and it can be used for K-12 education as well. Like the 529 plans you are giving control of your money to the trustee and the principal is susceptible to loss and if your child choose another path you will be responsible for income tax and the 10% penalty. IRA’s offer tax advantages and flexibility for funding a college education. With the added benefit that it is your money and if the child chooses a path other than college; the funds will continue to build for your personal retirement.
The downfalls are there is no guarantee you are your financial advisor will pick the right IRA to build long term growth. The principal is not guaranteed against loss. The funds are restricted, if there are other financial needs that would force you to make withdrawals from the IRA the penalties and taxes would be imposed. The UGMA & UTMA accounts are a good vehicle as long as you have someone with the financial means to fund it. The risk is the child will end up controlling the funds and there is no guarantee the new car isn’t going to be more exciting than paying for college.
The Infinite banking concept of using dividend paying whole life insurance is the only option that guarantees no principal loss, another words you won’t wake up one morning and find that the market crashed and now instead of having your child’s college fund almost funded you have another 30% to go and college is in the spring. It guarantees a rate return so you know from the start the worst case scenario. No stress just the facts. It is creditor proof and judgment proof so if you are sued or are being pursued by a creditor the cash value is protected. The funds in the policy do not count towards assets for financial aid as would stock accounts or UGMA accounts so if your child wins a scholarship you still have the flexibility to use the funds as you see fit.
The funds are liquid and available for emergency use at any time via policy loans and can be used for any purpose, so those major car repairs or plumbing incidents are not so major. An infinite banking policy also allows you the option if your child decides to back-pack through Europe to find themselves before choosing college. The funds will be there for use if you deem is a responsible way of spending the funds. Last and not least when your child graduates with honors they will be able to make payments back to their bank and every payment frees up available cash for them to reuse at a later date to finance a car, home improvements or any purchase where most of the population is forced to use a conventional bank. You will have given them the freedom of being completely detached from the banking system.
Using this concept will allow you to truly invest your money so that the principal is not at risk, has guaranteed growth, is tax advantaged and leaves a legacy both financially and in the form of an educated child that is prepared for their future. Scenario in real dollars: An eight year old girl in 2010 wants to go to University of California when she is 19. The total cost to go to the University of Ca. from their website is $27,000 to live on campus and cover all expenses.
Using the calculator on www.collegeboards.com and factoring 6% increase in cost. (the current rate of increase in cost) in 11 years it will cost $51,254 the total cost will be $224,217. This means to have that much in 11 years you will need to save 20,384 per year and $1698 per month. Total cost: $ 224,217 Your savings goal (100%): $ 224,217 Your Projected Costs If college costs rise at 6.0% a year, your annual cost will be $51,254 (up from $27,000 over 11 years). The total cost for 4 year(s) will then be $224,217.