With the costs of college increasing faster than other goods and services in the economy, it isn’t any wonder that studies show parents are more concerned about saving for their children’s college expenses than for their own retirements. But armed with information and good planning, there’s no need for parents to panic.
It was a chilly New Year’s Eve morning when my husband and I found ourselves at our local 529 college savings plan office. We were opening an account for our first child. With the tax year ending in twelve hours and the office closing in six, it felt like we had waited until the very last minute to start saving for our son’s education. The truth is, our son was six months old when we opened that account.
With the price of tuition and fees increasing faster than other goods and services in the economy, according to reports by College Board, a nonprofit association, even losing six months can seem like a major setback.
“More than ever before, parents have realized how important a college education is for their children,” says David Coppins, senior vice president for Upromise. “Coupled with skyrocketing costs, this causes many people to panic.”
But there’s no need to despair. Whether your child is six months or sixteen years old, you can still save, benefit from compounding interest, and reap tax benefits if you know your options. There is no time like the present to learn those options and make the right decisions for your family and situation.
An Interesting Ally
Many college grads scraped and saved to pay for their education, and while there is certainly merit in that route, it is increasingly difficult for prospective students to shoulder the burden of education expenses solely with summer jobs.
The College Board reports that since 1977, published tuition, fees, and room and board costs have increased an average of 2.7 percent per year for both private and public four-year colleges (adjusted for inflation), with dramatic swings in the most recent decade. For the 2007–2008 school year, costs of private and public four-year institutions were up more than 6 percent from last year. If that trend were to hold, a single year of school that currently costs $15,000 could cost more than $28,000 in ten years; more than $38,000 in fifteen years; and almost $53,000 in twenty years.
But your money can also grow during the next ten, fifteen, and twenty years. “Start early. It’s the time value of money,” says Lynne Ward, director of the Utah Education Savings Plan, Utah’s 529 college savings plan. “But if you start late, you still have the tax-free growth of the earnings, you still have the state tax deduction or credit. It’s never too late to save. I think that becomes an excuse, frankly.”
Ward adds that even if you start saving late, the more you save, the less you have to borrow. “The great thing about saving ahead of time is it minimizes student loans,” she says. Every dollar you save is a dollar—or more—you won’t have to borrow later. For every dollar you put away for your child’s college expenses, you will, theoretically, earn interest. For every dollar you borrow for your child’s college expenses, someone else will earn interest—from you.
Fortunately, you have options for making the most of the money you put aside. From tax-advantaged accounts to rewards programs, there are ways to get your children and bank account ready for college.
529 College Savings Plans
Named for the section of IRS code that governs them, 529s are a recent tax-friendly development that allows families to contribute to specially designated college savings accounts. Contributions are posttax, but the interest grows free of federal income taxes as long as the funds are used for approved college expenses at an accredited institution. The plans are state managed, and every state as well as Washington, D.C., has at least one option.
But you don’t have to live in the state to open a state-managed account—there are no residency requirements. You can utilize any state’s plan and spend the funds in any state.
“People ought to look at their own home state 529 plan first, because there might be tax benefits they can take advantage of,” Ward says.
But experts also recommend comparing plans to see if fees and plan flexibility are better elsewhere. For instance, some state taxes are so low that a tax break wouldn’t make up for higher fees, or some plans require minimum deposits or direct deposit while others do not. And you’ll definitely want to research the investment options offered by the plans you are considering to make sure they match your goals and risk profile.
Additionally, there are no income caps for the owner of the account (e.g., parents or grandparents), and the overall contribution limits can be as high as $300,000 per beneficiary. But there are taxes and penalties on funds used for something other than approved college expenses.
“It’s hard to beat 529 plans for tax-free college savings, a conclusion supported by the fact that Americans now have more than $100 billion stashed away in these investment vehicles,” points out Joe Hurley, a certified public accountant and founder of Savingforcollege.com, in his blog about 529 plans.
Prepaid Tuition Plans
Another 529 option is prepaid tuition plans, also known as Prepaid Education Arrangements. These plans allow you to lock in current tuition and fees by paying for all or part of a public, in-state education at today’s prices. You can purchase contracts for one to five years of tuition, and these plans are generally considered safe investments that often outperform typical savings accounts or CDs.
However, you are also locking in the school your child will attend, and there can be several other factors that may not be right for your student’s situation, including very narrow definitions of “college expenses” (e.g., only tuition and fees, not room and board), the risk that your child will not be admitted, and a potential impact on financial aid eligibility. Visit www.savingforcollege.com for a list of all 529 plan web sites.
Coverdell Educational Savings Accounts
Formerly known as the Education IRA, the Coverdell Educational Savings Account offers some limitations as well as some flexibility not found in 529 plans. Like a 529 plan, you contribute posttax, and the money grows tax free as long as it is used for approved educational expenses. However, unlike the 529 plan, the funds from a Coverdell ESA can be applied to private elementary and secondary schools as well as to institutions of higher education—an appealing option if you plan to send your child to a private school.
There are income caps for parents ($110,000 annually for single filers, $220,000 for married filing jointly) and annual contribution limits of $2,000 per beneficiary until the child’s eighteenth birthday, after which you can no longer contribute. But you can contribute to this account in addition to contributing to a 529 plan. “It is really tough to compare the Coverdell ESA and the 529 because each state has its own rules regarding the 529,” says accountant Donald Campbell of Accounting Business Services in Salt Lake City. His recommendation is to work with an accountant who knows your individual tax situation.
For a list of Coverdell providers, visit www.savingforcollege.com and click on “Coverdell ESA,” or seek recommendations from your financial advisor. With any college savings plan, be sure to discuss the tax implications for your individual situation with your accountant.
Rewards Programs
These aren’t savings accounts but rather rebate programs in which you get a percentage back on purchases. That cash back can then be deposited into an account, such as a 529 or an ESA account. Programs range from credit cards with cash back options, such as the FutureTrust MasterCard, to full-fledged rewards programs, such as Upromise, BabyMint, and LittleGrad.
College savings credit card programs work like other cash back cards. For every dollar spent using the card, you get a percentage back to apply toward a college savings account. FutureTrust, for instance, offers a MasterCard that gives one percent back on all purchases and larger percentages for shopping with partner merchants.
Full-fledged rewards programs also offer credit cards and additional ways to save. The premise is similar for each program: Register for the program, which may include registering your current credit cards and grocery store cards; shop at participating merchants; receive a percentage back on your purchases; and have that rebate deposited into your 529 account. In some cases, the rebates can even be used to pay down eligible student loans already incurred.
“It costs nothing to join or participate; it is essentially free money for college,” says Coppins, senior vice president for Upromise. He estimates that the very casual participant in Upromise can bank $20 or $30 per year, while a more aggressive participant can earn more—he has personally saved more than $5,000 using the program in the last five years.
Additional Options
There are a few other choices available to help you prepare for college expenses that might also fit your situation.
Traditional savings methods
CDs, stocks, mutual funds, and savings accounts are all options. But they are taxable accounts, so you lose any tax benefits offered by education-specific savings plans. However, the funds can be used for anything—not just education—so if there were a need to tap those funds, there is no financial penalty in doing so.
Uniform Gift to Minors Act and Uniform Transfer to Minors Act
Under these acts, a donor gifts money, securities, or even real estate into a trust for a minor. The money then belongs to the minor but is controlled by the custodian until the minor reaches the age of trust termination (generally eighteen to twenty-one). Once the favored way to pay for college, this unqualified gift to your child can offer tax advantages, and the money is not restricted to education. That makes this option very flexible, but the money belongs to your child. So if you want to control how the funds are ultimately used, you may be out of luck.
Grants and scholarships
Here’s a little bright spot. While the College Board has documented the continuous increase of published prices for tuition and fees, it has also documented the fact that students often do not pay those published prices. “About half of all college students and two-thirds of those enrolled full time receive grant aid that lowers the net price they actually pay,” according to Trends in College Pricing 2007, an annual report published by the College Board.
In addition, there are millions of scholarships and fellowships worth billions of dollars. Some are merit based, some are needs based, and some have quirky requirements like ancestry who sailed on a certain ship or a minimum height requirement.
As you prepare to pay for your child’s college education, be sure to research potential grants and scholarships for which your child may be eligible. Start with the school’s financial aid office, and then do your own homework online. The College Board reports, “There’s more financial aid available than ever before—more than $90 billion. And, despite all of these college cost increases, a college education remains an affordable choice for most families.”
Starting Them Young
UESP’s Lynne Ward overheard a conversation between her daughter and a cousin. They were discussing what they might get for Christmas, and the cousin speculated that she would be getting money. Ward’s six-year-old daughter responded, “You better put it in your 529 account.”
“She’s six years old, she knows we’re saving for college, and she’s expected to go to college,” Ward says. “Saving money sends a message to the child that says we want you—and we expect you—to go to college.”
It’s a message any parent can send to their child of any age. Whether your child is just learning to read or is about to take the SAT, by examining your own situation and setting up a college savings program that fits your budget, your child will know just as Ward’s daughter knows: College is a priority, and we will help you get there.
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Article written by Lisa Ann Thomson
Illustrations by Michael Austin
About the Author
Lisa Ann Thomson is a freelance writer based in Salt Lake City, Utah. She writes about business, travel, and home for magazines, and her latest book project is The Better People Leader, written with business consultant Charles A. Coonradt.
