If you have children you are probably putting together some plan for their future education, but what is the best way to pay for college?
The good news is there are multiple options that not only allow you to save for college, but can also have tax advantages.
Why You Need to Save for College
As of this writing I am 40 years old. I took longer to get out of college for various reasons, not the least of which was that I went part time for my three semesters, that could have been done in two, so I could work and not rack up any extra student loan debt.
This was more than manageable in the late 90’s and early part of this century because college expenses had not yet completely blown up.
With the availability of easy student loans and colleges continually raising their prices I am not sure I would be able to take that same path now and get out of college in a reasonable amount of time.
I am not sure whether college is the right path for all of my children, but if they are serious about school I want them to be able to pursue higher education without them being saddled with tens of thousands of dollars of debt.
While you may not feel like you need to pay for all of your children’s education, having some funds available to them will make it much easier for getting them on their path to adulthood.
Tax Advantaged Options for College Savings
The government has realized that people need ways to save for college and that it is good to encourage this investment. These three types of accounts can help you save and avoid a visit from the tax man.
Since saving for college should take more than five years we need to consider it a long term investment. Just like saving for retirement there are types of accounts that have tax advantages. The most widely used plan is called a 529 plan.
All 529 plans are sponsored by a state. Meaning there are 50 different 529’s. You can put your money in whichever state plan you want and can spend that money at whatever college you would like to.
The money going in is post-tax (meaning you have already paid taxes on it) and grows tax free (meaning you do not have to pay any taxes on the interest) if you you use it for college expenses, such as tuition, fees, books, supplies, and room and board. Basically the 529 is the college savings equivalent of a Roth IRA. Many states offer tax deductions on state income taxes for residents if you contribute to their plan.
The only other thing you need to remember is to use the mutual fund investments available in these plans. You don’t want to be investing in bonds or money market accounts.
Many plans now offer target date funds that get more conservative as your child gets closer to college age. If you don’t have a target date option, do your home work but invest in mutual funds until you get withing 5 years of your student going to college.
Coverdell Educational Savings Account
The second savings vehicle for higher education is called the Coverdell Education Savings Accout (or ESA for short). The ESA can be an effective way to save for college. Just like the 529 it is post tax money and the interest it earns is tax deferred. There are some downsides compared to a 529. First, you can only put $2,000 dollars into it each year.
So if you started late on saving for college it restricts you a little. Second, it can cause problems with certain deductions and tax credits. And third, the money in an ESA actually belongs to the student not the custodian of the account (usually the parents). The biggest advantage of the ESA is that is can be used to pay for primary and secondary schools.
So if you want to send your kids to private school you can use the account for those expenses. Also your state determines how much you can have in a 529. So if you need more than that, say for a child that wants to be a doctor, you can use the ESA as an alternate means to save.
UTMA and UGMA Accounts
UTMA and UGMA stand for Uniform Transfer to Minors Act and Uniform Gift to Minors Act respectively.
The accounts themselves are in the students name and cannot be transferred to the parent or a sibling. They do however have a custodian until the child is of age (18 for UGMA, 21 for UTMA).
The accounts grow tax free for the first $1,050 and at the child’s tax rate for the next $1,050. After that you get the full rate of the parents income taxes.
The biggest issue with this account is that it belongs to the child and, once they no longer have a custodian, they can withdraw the money for any reason.
So if you have a child who isn’t the most responsible, you might end up paying for their trip across Europe instead of the college degree you thought you were saving for.
Other College Saving Options
High Interest Savings Account
I am a big fan of high interest savings accounts for building your emergency fund. These accounts work just like a normal savings account but you get much higher rates.
If you are going to use a high yield savings account or even a high interest CD for your child’s education, I would recommend keeping them in your name. That way you have complete control and when they do an evaluation for financial aid it gets values much lower than if in your child’s name.
Prepaid tuition plans allow you to lock in the current tuition prices by paying for college now and guarantee that tuition is paid for in the future. Typcially where you can go is limited to state colleges, but with the way college tuition is increasing this might be a great option for your family
Currently, pre-paid plans are only available in these states:
This one may seem off since these are retirement plans, but bear with me.
Just like a 529 the interest in a Roth account grows tax free. What most people do not know is that you can withdraw the principal in your Roth with no tax penalty.
The benefits of this are two fold. You have a way to save for your child’s education and the interest that is earned can go toward their retirement. This is setting them up for big success on the retirement front.
The downside is that your child will have to have earned income and you cannot put more than they make in earned income into the Roth.
You are also giving up any interest earned as a possible means of paying for college.
Saving tips for Students
If you are a student reading this and do not have the resources to save thousands of dollars in a short period of time, there are options that can help you reduce the cost of college
More and more school districts are offering dual enrollment for their students. You can attend part of your day at your high school and then another part at a local community or technical college.
Many students are graduating from high school already having achieved an associates degree. This means they can start working in their future field immediately while paying for school
Experience and less time spent getting a degree is a big win win. Just make sure the classes your child are taking will transfer to the college of their choice.
Advanced Placement classes are a way to earn college credit by passing an AP exam at the end of the year. I took several AP classes in high school and I will tell you they were more difficult than the classes I had to take in college.
While these classes are a great option to get college credit as you go, I will tell you that if you are not good in situations where taking a single test determines your success, then AP is not your best option.
Apply for Scholarships
There are TONS of scholarships out there and they are rewarded for many many different reasons.
What it takes to get them is being consistent and meeting their requirements over a long period of time. There are scholarships available for people as young as eight years old.
If you aren’t familiar with applying for scholarships checkout my college scholarship guide to help you get started and know where to look.
Apply for Grants
Grants, like scholarships are plentiful. They work in very similar ways in that you get free money for school.
Grants are frequently more specialized than scholarships, but if you meet the requirements you have a great chance of getting them.
The most types of grants are:
- Course/Career specific
So many people either don’t know or don’t even try this route when trying to pay for college.
College is getting more and more expensive and there doesn’t seem to be an end to how high the costs may go. Getting started today on your child’s education can pay off big time when junior is ready to get a degree.