7 Ways to Save for College
Last week we discussed that it’s never too early or too late to start saving for college for your kids, and one of the first things you need to do is identify what your goal is and how much you want to cover for them. The next step is then to figure out where to save for college and that’s where we’re going to spend today. There are lots of options when it comes to saving for college and we’re going to cover seven of them today.
The first option is the simplest and most straightforward – you can just open a savings account in your bank and save monthly or weekly into that bank account, and then use it for college when it gets time. The second option is you can set up a brokerage account and save into a ‘taxable’ account, just like you would for any other goal (like a car purchase, home purchase, etc.). By saving into a taxable account, you are also participating in the market. The thing with these first two options is that neither of them really offers any tax benefits when it comes to saving towards college and they both will be counted against you when looking at the FAFSA and trying to determine eligibility for student aid.
A third option is an UTMA or UGMA – an UTMA is a Uniform Transfers to Minors Account. The way these work is the parent is the custodian of the account for the benefit of the minor – the funds put into the UTMA need to be used for the minor but they don’t have to be used for educational purposes. So, if you don’t know if your child is going to go to college, that may be a way to save that can be used for college or can be used for something else. Either way, it needs to be used for the child! The caveat becomes once that child reaches age of majority, which here in Texas is 21, those funds are theirs to do with as they please! So, if they’re responsible, they can use it for a car purchase or they can keep it for the down payment on a future home, but those funds are then at their own discretion.
Option number four is one of the more popular ones and is probably one that you’ve heard of – the 529 plan. When you put money into a 529 plan, it grows tax-deferred and then when you withdraw those funds, they are tax-free if they’re used for educational purposes. If they’re not used for educational purposes, the withdrawals are taxed as ordinary income and there is also a 10% penalty that goes with it. Educational purposes are things like room and board, tuition, books and fees – they are pretty liberal on what counts for educational purposes, but it must be used for educational purposes. The fifth option is a Coverdell, which works very similarly to the 529 plan and has to be used for educational purposes. One of the big differences is it only has a $2,000 annual contribution limit, so you’re very limited in how much you can set aside in a Coverdell to be used for college.
The sixth option is a prepaid tuition plan. Since we’re so close to College Station, if you know for a fact that your child will go to Texas A&M and ‘be an Aggie for life’ or they can’t go to college at all, then you can pay up-front or in-advance that kids’ tuition. The point behind a prepaid tuition plan is to avoid the rise of education costs because education has been rising rapidly and easily outpaces the rate of inflation. So, the goal is to pay for it in advance – say when your child is 8, pay for it all upfront and avoid 10 years of rapid increase in the cost to go to A&M.
The seventh option is one we don’t really recommend, but you can use a Roth IRA to pay for your child’s education. If you pull out money from a Roth and use it for educational purposes, it avoids some of the penalties that are associated with taking money out of a Roth before 59 ½. However, Roth IRA’s are “Roth Individual Retirement Accounts” – catch that?! Retirement, it’s meant to be used for retirement as its main purpose. So, if you pull funds out for education for your child, those funds aren’t there to continue to grow for you for retirement. We always tell our clients “You know you can borrow for college, there’s no way you can really borrow for retirement.”
Now I know we covered a lot of options, so there’s a lot out there and there’s a lot of details that we didn’t really touch on – how do scholarships affect these plans? How does the student aid come into play? Etc. If you want to talk about what plan is right for you or for your child or want to talk about how you go about setting these up, you can always reach out to us here at Next Step. We’d love to help you figure out what the right option is for you, based on what you are trying to do for your kids. Y’all have a good one!