College is a stepping stone for many to a higher paying career. It’s no wonder that many parents want to help their children attend college. But college tuition is expensive, and the costs are rising every year. This fall’s college tuition is expected to clock in at $31,231 for private, nonprofit, four year universities, and $9,139 for public, four year universities. Many parents wonder if they will be able to foot the bill.
Smart saving for college is a great way to prepare for the cost of college. Learn about some of your options to make the most of your savings.
529 accounts, also called qualified tuition plans or college savings plans, are a great way to save for college. These plans allow you, a relative, or a friend, to contribute to an account for your child’s college education.
Two broad types of plans exist: investment plans, and those for prepaid tuition. With investment 529 accounts, parents (or other account owners) pick out investments. They can either do this directly or with the help of a broker. Prepaid tuition plans go towards purchasing semesters at select colleges with the plan controlling the investment decisions. If your child decides to go to a different college than the one specified in the plan, most plans pay out an equivalent amount. Both plans can work, though you’ll certainly want to dig into the details to figure out what’s right for you.
529 plans offer tax-free growth. This means you pay federal taxes on the money you contribute, but you are able to withdraw the earnings tax-free on qualified college expenses such as tuition, fees, and books. Some states also allow deductions on state income taxes for 529 contributions, though the amount of state deduction varies greatly from state to state. There are no income restrictions on who can contribute, unlike other options. Parents (or account owners) are each able to put up to $14,000 per child per year each into the plan, and some plans allow you to put a lump sum in at one time.
In addition to the tax benefits, 529 plans have a minimal impact on the financial aid a student can receive. 529 accounts are usually reported as parental assets on the federal financial aid application. Grandparents may want to look into the student aid ramifications of having a 529 account for their grandchildren; withdrawals from grandparent owned 529 plans may count more heavily against possible student aid than parental accounts.
Due to their versatility and tax benefits, 529s are a great way for parents to save for college.
A Coverdell Educational Savings Account is another tax-advantaged savings account for education. However, this account can be used for more than just higher education costs. Parents can use the account for educational expenses from kindergarten through graduate school.
Coverdell benefits are limited, so it will probably make sense to concentrate on other plans for college savings. You’ll want to contribute no more than $2,000 as additional contributions are subject to an additional tax. Usually, parents can only contribute to a Coverdell account up to when the beneficiary is 18, and the funds will be subject to penalties if not used before age 30. There are also income limits for contributions.
In most cases, a combination of other methods will be simpler and offer more flexibility.
A Roth IRA is another great way to contribute towards your child’s college education, especially if you’ll be age 59 ½ or older while your child is attending college. Account holders can withdraw their contributions at any time, but you’ll be eligible to withdraw your investment earnings tax-free after the age of 59 ½.
Roth IRAs are helpful as they have no restrictions on how you can use the money upon withdrawal. This builds some flexibility into your college savings plan. If college costs less than expected, there’s no need for finagling to get the money out of a 529 plan. Families with multiple children can always change 529 beneficiaries to younger children, but those with only children have less options. Supplementing 529 savings with a Roth IRA is a great way to avoid over-funding the 529 plan.
Roth IRA assets usually aren’t counted in federal aid calculations. But withdrawals from earlier years may factor into calculations. If possible, consider leaving the Roth IRA withdrawal for the last year of college to get a more favorable financial aid package.
Since Roth IRAs do have income limits for contributions, only some parents will be able to use this strategy. Roth IRAs do have a smaller yearly contribution limit ($5,500 if under 50, $6,500 if older for 2015). This account will most likely be one part of an overall strategy.
Savings or Brokerage Account
Another great place to save for college is in a regular savings or brokerage account. There are more college expenses than those that qualify under a 529 account, so it’s important to not have the entire college account locked away.
And there are a lot of kid-related expenses on the way to college. Having money in a savings or brokerage account means the money can be used for braces, a car, or even in an emergency if needed.
There Are Many Ways to Pay for College
These accounts are great ways to save for college. But if you wonder if you’ll ever be able to save enough for college, don’t despair. There are many ways to pay for college, including student loans, scholarships, grants, and part-time jobs. By making the most of the money you are able to save, you’ll be well on your way to putting your kid through college.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes everyone should have access to financial resources and coaching. For more information on the services offered, contact Katie today.