Step 8 – Save for Future College Expenses
The 8th step to financial security is to save for future college expenses…
Only a small percentage of students get enough financial aid to cover their tuition, housing, books, and fees. As a result, saving for college is a major financial goal for many people. Luckily, it is as easy as 3 numbers…5-2-9, as in using a 529 plan. 529 plans allow parents or grandparents to put money aside in a tax advantaged way that can later be used for college. In addition, those of us in the military who are willing to serve a little longer can transfer our GI Bill to our children, which can help with college costs, sometimes covering them completely. That’s my plan, as I’ve got two kids and two GI Bills.
How Expensive is College?
In 2014, the average family paid $13,461 for college, which was only 64% of the total cost of tuition, room and board, and other expenses. For the 2014-15 school year, the average public college cost $18,943 while a private institution cost $42,419. If that wasn’t enough, educational costs are increasing at a 6% rate annually.
How Can You Limit Costs?
Get your kids to go to a state or public school. Once you’ve got your degree and are working, no one really cares where you went to school. Work ethic, intelligence, creativity, and other characteristics make or break your success, not an Ivy Leage pedigree. State schools are just fine.
One other strategy is to have your kids go to a community college for the first 1-2 years of their education, later transferring to a four year college or university and getting their degree.
The money in 529 plans can be invested in stock and bond funds. As long as the withdrawals are used for qualified higher educational expenses, the investment gains are free from federal taxation.
As of 2017, you can contribute as much as $14,000/year to each child without incurring the federal gift tax. In addition, you can pre-fund up to 5 years of these contributions, or $70,000 in 1 year. Couples can give $140,000.
Sound too good to be true? Well, it is true, which is why 529 plans have come to dominate the college saving game.
Downsides of a 529 Plan
If you don’t use the proceeds of your 529 plan for educational expenses, your gains are subject to income tax and a 10% penalty. In addition, colleges will consider 529 assets when determining need-based financial aid. If you believe you’ll be eligible for financial aid, you might be better off keeping the assets in your name or the names of the grandparents.
That said, the amount you’ve saved for college has much less of an impact on your financial aid than your overall income does. In other words, families with high incomes will be expected to pay for at least part of college regardless of whether they saved for college.
As Usual, Taxes and Costs Matter
Not all 529 plans are perfect. Each state offers a plan, and you can use the plan from any state. You are not limited to the one you live in.
There may be some state tax benefits if you use your state’s plan, but just like with all investments you have to see if those tax benefits outweigh the other features of the plan. Some states have high fees and expenses or have less than optimal investment options. Some states give you tax benefits no matter which states’ plan you use.
Which 529 plan do I use? Regular readers would guess that I use whichever state’s plan is run by Vanguard, and they’d be correct! Vanguard administers the Nevada plan, which is what I use. They also provide management and services in the Colorado, Iowa, Missouri, and New York plans. Many states, though, offer Vanguard and other low cost investment options.
You find a lot of good information on 529 plans at:
Other Types of Accounts
Here is a great table from the Vanguard website that compares benefits offered by 529 plans against various other types of accounts people use to save for college:
|529 Plan||Uniform Gifts/Transfers to Minors Act (UGMA/UTMA)||General Investment Account||Education Savings Account (ESA)|
|State tax breaks||X|
|Federal tax breaks||X||X|
|Low financial aid impact||X||X||X|
|High contribution limits||X||X||X|
|Access to your money||X||X||X|
As you can see, while there are other options, the 529 offers the most benefits. Some people advocate using Roth IRAs, whole life insurance, or ultra-conservative investments like certificates of deposit (CDs) or savings accounts, but this is generally a bad idea.
You need your IRAs to save for retirement, not college. Saving for retirement is your top priority, even over funding the college education of your children. You can borrow money to pay for college, but you can’t borrow money to retire.
Life insurance is expensive and generally offers very low investment returns. CDs and savings accounts aren’t expensive, but their investment returns are just as anemic. With educational inflation at 6% annually, it will be hard enough for stocks and bonds to keep up let alone life insurance or CDs/savings accounts.
The GI Bill
If you have served in the military after September 11, 2001, you are eligible for the Post-911 GI Bill. It covers four academic years, including tuition and fees, housing, and books up to 100% of the cost of the most expensive public school in your state. For private schools, it will cover up to $22,805.34 of costs. Some more expensive schools participate in the Yellow Ribbon Program to bring their tuition down closer to what the government will pay. In some situations, you can transfer the GI Bill to your spouse or children.
You can find a ton of information on the GI Bill at this website:
Specific information about transferring your GI Bill is here:
What’s the Bottom Line?
529 plans have become the go-to account for most people saving for college. Go to SavingForCollege.com to find out which state’s plan is right for you. If you have a GI Bill and are willing to transfer it to your children for their future college expenses, check out the link above for all the details