It’s back to school time. Your little charges may be getting dropped off at preschool, boarding a bus for elementary school or driving themselves to high school. Regardless, at some point in the not so distant future they may be heading off to college. That carries a financial wallop. It’s never to early to start planning.
The price tag hanging on college educations can appear staggering. Private Colleges average $22,000 for just tuition, fees and books. Living is extra. Here in Connecticut, UCONN will set a student back just over $17,000 for the full package of tuition, room board and books. Even Connecticut’s two year colleges cost $3,300 for tuition and books. The room and board is extra. (Source: The College Board 2006-2007 Survey of Colleges.)
The price, however, is often well worth it. In financial terms, college graduates earn an average of 60 percent more than people with a high school diploma. (The College Board, Education Pays 2007) In addition, the experience often confers maturity and allows for more options and freedom.
But how to pay? Like all things financial, there is no one right answer for everyone but a variety of options and strategies that can be pursued.
One is waiting and paying out of pocket or relying on aid. This is the most dangerous, as most aid arrives in the form of loans that need to be paid back.
Some sort of pre-funding college is often prudent. There are many good options available ranging from traditional college accounts to less traditional strategies. Most will employ some form of tax deferral.
The traditional college accounts are now state sponsored 529 plans. Every state sponsors at least one. People can use any state plan, but up front tax advantages often require the use of a resident state’s plan. In Connecticut and New York, for example, state residents get state income tax deductions for contributions to state plans up to $10,000.
Section 529 plans work like Roth IRA for higher education. Contributions are made with after tax money. The money can be invested in an array of options, depending on the state plan. It grows tax deferred. When it’s spent on qualified higher education expenses, the gains will not be taxed.*
There are also pre-paid tuition plans. These allow people to lock in today’s tuition rates, effectively hedging against inflation. A downside is that they tend to be state or school specific.
Education Savings Accounts, which work like 529 plans with a few differences. Joint filers with incomes greater than $220,000 cannot contribute. Nobody can put in more than $2,000 a year per beneficiary. This money can be spent on K-12 education expenses, in addition to college.
Other options include Roth IRAs, traditional IRAs, cash value life insurance, taxable savings and investment accounts and uniform gift to minor accounts. Each of these can be appropriate for families depending on their unique circumstances.
A Roth IRA, for example, might be a good choice for family that wants to maintain a favorable position for needs based financial aid and whose adults are retirement age or near retirement age when a child hits college. For families with younger parents, a cash value life insurance policy may provide similar benefits. For a family that has significant retirement assets but little non retirement savings, tapping an IRA penalty free for qualified higher education expenses can make sense.
Education is more valuable than ever—and more costly too. Fortunately, families have many good options for accumulating resources to pay tuition and other expenses. There is no one best way. There are a variety of tools that can be used build a plan to suit a family’s unique needs. Like most things financial, the best strategy is to get started as early as possible. Contact a professional and design a plan. Time, combined with prudent tax advantaged investing, makes a little money stretch a long way.
*529 Plans are established by states or eligible educational institutions under IRC Section 529 as “qualified tuition programs.” There is no guarantee offered by the issuing municipality or any government agency. You should consider the potential benefits (if any) that your own state’s plan (if available) offers to residents prior to considering another state’s plan. There may be tax benefits to plans offered by your resident state. Non-qualified withdrawals from a 529 Plan are subject to a 10% federal tax penalty and current income tax and may also be subject to state tax penalties. As with all tax-related decisions, consult with your tax advisor.