Invest in Your Child's Future: Strategies For Financing Education
Last updated: December 29, 2008
When I was in high school in the 70's, it was never a question of "if I go to college", the question was always, "what college will I attend?".
My parents made it very clear that my future would include a college education, and further emphasized that I would not be allowed to hold a job during the school-year; my job was to focus on my education, a selfless decision on their part and one I have
been grateful and appreciative of all my life. They encouraged me to apply for scholarships both athletic and academic, both of which I was able to obtain in varying degrees, and then they funded the remainder out of pocket. I felt pride that I was able
to cut their burden by half; but the cost of my engineering degree obtained at an in-state university was perhaps a "mere" $12,000 twenty-something years ago. My, how things have changed, though...
Over the past 30 years, the cost of attending college has risen an average of 7% a year, exceeding that of inflation. For a child born today, that will equate to a bill of perhaps up to $350,000 to fund four years at a private university.
As a single parent in my forties with a kindergarten age child, I am faced with the dual responsibility of planning for retirement and financing my son's education. With many of the tax loopholes used in the past (like putting appreciated assets in the child's name) now closed,
new strategies must be found to save for this important-- and crucial-- first step in a child's adult life.
As the focus of this article is more about ways to save and plan for this expense in advance, we will not focus on the many ways that your child can earn some or all of their education expenses by winning scholarships or grants - but this is worthy of mention as there are a significant number of programs available. If you are fortunate enough
to raise a child who is bright and saavy enough to qualify for these many opportunities, your college savings can happily be utilized for other purposes. Given that these funding alternatives cannot be planned for, but are earned later in life based on merit, one must
still plan to have the financial cushion available for the expenses regardless.
The most popular strategy available today is the 529 College Savings Plan, "Qualified Tuition Programs" which were created in 1997 for tax-deferred college investing.
In 2006, Congress made the tax-free treatment of withdrawals used for educational expenses a permanent feature, and the funds in a 529 plans can be used for all educational expenses including books, room, board, tuition and miscellaneous fees.
Available in all states except Wyoming, a 529 savings plan can be utilized without limitation as far as choice of schools, and can even be used to fund attendance at accredited foreign universities.
Here is a brief summary of the positive features associated with 529 College Savings Plans:
- Grandparents or other relatives can contribute. The key advantage here is that if a non-parental relative has funded the plan, these assets will not be taken into consideration if the student is applying for financial aid as well.
- The account owner controls the funds. Whether the owner is a parent, grandparent or other relative, they have full control within the investment options, withdrawal options, as well as choice of beneficiary(s).
- Significant tax benefits both federal and state level. The tax-deferral and tax-free withdrawal features aren't the only potential tax benefits; in 34 states, there are additional state income tax deductions available for 529 contributions.
- They are "transferable". If you are lucky enough to not need the full amount, you can change the beneficiary (some limitations may exist here)- even passing them down to the next generation.
- Contributions are treated as gifts to the student. The annual gift exclusion is currently $12,000 for an individual ($24,000 for married couples) so you can gift up to this amount per year to a child's 529 plan without tax implications.
- Lump-sum gift exclusion. The IRS allows a lump-sum gift of 5-years worth of annual exclusions in a single year (donor surrenders the ability for the next 5 years) but this is certainly a useful strategy if college is close at hand.
Many states also have a 529 Prepaid Tuition Plan, which allows an individual to pay the tuition for a state educational institution in advance in a lump sum, thereby locking in the current tuition rates.
Another savings strategy is called a Coverdell Education Savings Account, or ESA. These accounts are similar to 529's in that they are tax-deferred and tax-free when the money is withdrawn for approved educational expenses,
which includes tuition for any sort of schooling (including elementary level). The main difference is contributions are much more limited at $2000, and there are income limitations for contributors (although anybody can contribute who meets the income requirements, not just relatives). The account must be depleted when the beneficiary
turns 30, or there will be a 10% penalty and the gains will be taxed.
Traditional and Roth IRAs are another good tool for financing education, as money can be withdrawn for educational purposes without incurring the ten percent penalty. An even better option is having the child fund an IRA in his or her own name,
assuming they have some earned income to contribute, and then they have the option to used some of these funds for educational expenses as necessary.
Purchase Zero-coupon Bonds. These are bonds that pay all their interest at maturity as opposed to providing a regular interest income stream over time.
The advantage is that the bonds may be purchased for a substantial discount compared to their face value at maturation. (Of course, in today's economic times, who knows!!).
Open custodial accounts such as UTMAs and UGMAs. Less popular than they have been in the past due to closing of "kidde tax" loopholes, these custodial accounts are tools that allow children to have ownership of assets without the creation of a trust.
In Summary: For those folks with children, integrating a plan for saving for college education into your overall financial life plan has become more crucial than ever before.
Education is a necessity in today's society for success, and the costs for obtaining this necessity are skyrocketing. With some advance planning, diligence and committment, you can provide your child with a gift that may make the difference between a fulfilling life-- or just a life.
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