The value of a college education has never been higher. Unfortunately, the same is also true for the cost of obtaining that education. With tuition rates skyrocketing, two-thirds of all students have been forced to take out an average of $23,000 in student loans. Fortunately, parents who want to help their children pay for college have a variety of options when it comes to saving for school.
1. 529 Plans
There may be no better way to save for college than through a 529 plan. There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans give you the opportunity to pay future tuition costs at today’s prices — a significant benefit given that college costs have increased at three times the rate of inflation in the past 35 years. Alternatively, college savings plans, which have no age or income restrictions, allow parents to save a sizable amount of money – up to $300,000 per child in many state plans — and withdraw it for qualified education expenses without paying any taxes.
2. Individual Retirement Account
Although an individual retirement account (IRA) is designed primarily as an investment account for retirement, it can also be used to pay for your child’s schooling. Under normal circumstances, a 10% tax penalty is charged on any money that is withdrawn from a traditional IRA before the age of 59.5 years old. However, that penalty is waived when the money is used for qualifying education expenses, such as tuition, books, and room and board. In addition, it is important to remember that contributions to a Roth IRA can always be withdrawn at any time and for any reason without a penalty.
Most parents have 18 years to save for their child’s college education; with such a long time horizon, you can afford to take some risks in your taxable portfolio by investing some funds in a diversified equity mutual fund. In fact, given that the average total cost for an in-state college education is more than $17,000 per year, it would be very difficult to save enough money without relying on the potentially higher returns of stocks. So once you have fully contributed to your tax-advantaged accounts, you may want to consider increasing your equity exposure in a taxable account.
4. Savings Bonds
As your child approaches high school graduation, your portfolio will have less time to recover from potential declines that occur in the stock market from time to time. Therefore, capital preservation becomes an important part of your asset allocation strategy. Although savings bonds do not offer particularly attractive interest rates, they do help to minimize risk in your portfolio. They also come with substantial tax benefits; not only are savings bonds exempt from state and local income taxes, but interest is also exempted from federal income taxes when used for qualifying educational expenses.
5. Certificates of Deposit
In addition to bonds, certificates of deposit (CDs) can also be used as a low-risk asset to save for college. Although they do not have the same tax benefits as savings bonds, CDs can be purchased with a variety of maturity dates, which makes them attractive short-term investments. With this flexibility, you can avoid the three-month interest penalty that the government charges if you redeem savings bonds within their first five years of existence.
Funding your child’s education is a financial goal that requires a targeted, long-term approach to saving. If you need assistance in developing a strategy, Pathway Financial Planning specializes in college savings planning and can assist you in a selecting investment options that will help you successfully reach your college savings goals. Please give us a call at 248-567-2160 or send us an email at firstname.lastname@example.org to set up a free initial consultation.