Growing up I never gave college much thought and it was never really pushed as a priority from my parents. When I decided to go, I went into the process blindly and ended up graduating with a healthy amount of student loan debt and that was ten years ago! Today the average rate for 1 year of tuition, room and board is $20,090 and costs continue to rise faster than inflation every year.
So why did nobody ever tell me?! Why did they keep telling me to fill out these so called FASFA’s and keep giving me money?! Why did they not explain the full impact of these decisions to my immature, 18 year old brain?! Probably because it’s not their job. I shouldn’t have relied on a financial aid advisor to care about my financial future but instead should have realized that they’re employed by the school to ensure I secure the funding to attend their institution. Before you let your own child wander into a mess like this, here are the best ways to begin saving for college.
529 College Savings Plan
Saving in a 529 Plan is an easy way to begin saving for college costs. The majority of plans allow you to begin an account with a minimum $50 contribution and most have an age-based investment option that will automatically adjust the investments based on the child’s age. It’s very hands-off and all of the earnings accumulate tax-free and are not taxable when the funds are used for college costs. They are very flexible in that you can transfer the account to any family member such as a sibling or grandchild if the original intended beneficiary chooses not to attend college. Also some states also offer an income tax deduction for contributing to their state’s 529 Plan. Just be aware that if the funds are used for non-college expenses, those earnings become taxable and incur a 10% penalty. I personally have used the College Savings Iowa 529 Plan as they use low-cost Vanguard funds but do your own due diligence and compare 529 plans at College Savings Plan Network.
Note: By using a state’s 529 Plan, your child is not required to attend college in that state unless it is a pre-paid tuition plan.
Coverdell Education Savings Account (ESA)
A Coverdell account works just like a 529 Plan in that the earnings grow tax-free and offer tax-free withdrawals when used on education expenses. The difference is that an ESA is not just for college but can be used on any education expense including grades K-12. You also are only limited to contributing up to $2,000 in these accounts. So if private school (K-12) is in your future, this may be a good option for you. Like the 529 Plan, distributions from a Coverdell for non-education expenses mean the earnings are taxable and have a penalty of 10%. Any unused funds left in the account can be transferred to another beneficiary to be used for their education or will be distributed to the current beneficiary upon reaching age 30 incurring the penalties described above.
Uniform Transfers To Minors Act (UTMA/UGMA)
An UTMA/UGMA account allows minors to receive money, securities, real estate, and other investments managed by a custodian (usually a parent or grandparent) for the benefit of the minor until they minor reaches their state’s legal age (18 or 21). The account shields the minor from tax consequences on the gift, up to a specified value, until the age of majority. When the minor becomes an adult, the UTMA account is converted to a regular, taxable account. This is a great option if a parent or grandparent want to take advantage of the gift tax exclusion up to $14,000 and gift that to a minor or have several investments that need to be gifted. The downside is the child receives full control over the assets after the age of 18 (or 21) and the value of the account can negatively affect the amount they would qualify for financial aid.
Originally intended as a great way to save for retirement, contributions to a Roth IRA receive no tax deduction but the earnings grow tax-free but enjoy a unique tax advantage to be used for college as well. Roth IRA withdrawals are treated as a “return of contribution” first and earnings as second. This means when a withdrawal is made for qualified education expenses you receive your contributions back to pay for the higher education expenses of a loved one with no penalty. Only when you get into the earnings part do you have to worry about taxes for those under age 59 1/2 or for those who have held the Roth less than 5 years.
Plan Your Strategy
There are thousands upon thousands of resources available to educate you on ways to save on college costs as well as to secure funding along the way. From finding a college that is a good match for your student to preparing for the SAT, there is a wealth of information available. Here are some resources to check out:
Dept of Education – Student Aid – Information on grants, scholarships, work-study programs, and loans.
College Board – Information on SAT testing, CLEP tests, and searching for a college based on your requirements.
Saving For College – Information on financial aid, scholarships, and 529 Plans.
FastWeb – Apply for scholarships.
Scholarship Experts – Apply for scholarships.
Disclaimer: I am a CERTIFIED FINANCIAL PLANNER TM (CFP®), but I am not your CFP® or financial advisor. The information in this article is for general informational and entertainment purposes only and does not constitute financial advice. This article does not create a financial planner-client relationship. The author is not liable for any losses or damages related to actions or failure to act related to the content in this article. If you need specific financial advice, consult with a licensed financial advisor, CFP®, or tax professional who can tailor advice regarding your specific circumstances. Additionally, sometimes I use affiliate links to support my website. This means I may earn a small commission, which is no additional cost to you, for referring and discussing products and services that I personally use, or have used and trust. Thanks for your support!