6 Best Ways to Save for College

by Bryan Ward CFP® #ProCoreAdvisors #QuickVest

With the cost of attending a traditional 4-year university somewhere between ridiculous and ludicrous, many students and parents alike have looked towards cheaper alternatives such as online universities or attending a junior or community college for the first year or two before transferring into the traditional universities. And, of course, we would all like to believe that our child will receive a full academic or sports scholarship leaving us with little to worry about. But reality is, very few full-ride scholarships are handed out, and unless a wealthy relative decides to front the bill, there is a good chance your child will join the other 70% of students that resort to some other means for financial aid (1). Below, Bryan from proCore Advisors discusses the 6 best ways to save for the cost of college.

#6 Education Savings Bond Program (EE or I Bonds).

Usually purchased by grandparents and given as gifts. You used to be able to purchase the paper bond at your local bank, but now these bonds are only offered in electronic form through TreasuryDirect.gov. These are long term bonds that are purchased at half the value and are redeemed 20 years later at the full value. Example you buy a $100 EE bond at $50 and in 20 years it can be redeemed for the face value of $100.  There is no tax due if redeemed and used for higher education.

PROS: None.

CONS: Too many to list. If you or your child receives one of these as a gift, I recommend redeeming and transferring into an educational savings account or 529 plan.

#5 The UGMA. The Uniform Gift to Minor’s Act.

This used to be a preferred savings vehicle for children but can hardly compete with today’s tax advantage plans. In essence, you’re making a cash gift to your child and are able to invest it however you like. The investments grow and are withdrawn at your child’s lower tax rate.

PROS:

1. The money can be used for anything, not just education.
2. Each parent can gift up to $14,000 without having to file a gift tax return

CONS:

1. This is a completed gift to your child, and it can never be taken back. It’s your child’s money at 18 or 21depending on the state you live in and the child can use it for whatever they wish.
2. Is counted as assets in child’s name if applying for financial aid.

#4. The Education IRA, or Education Savings Account (ESA).

Works very similar to a 529 plan which allows you to contribute after-tax dollars, the investments grow tax-deferred, and the dollars may be withdrawn for qualified educational expenses tax-free.

PROS:

1. Inexpensive to set up and manage.
2. Can be used for K-12 expenses in addition to college.
3. You control the investments which can be invested in anything you choose and in any manner that you like.
4. You can contribute to both a (ESA) and 529 plan for same beneficiary.
5. You may change beneficiaries to immediate family members including step-relatives and in-laws.

CONS:

1. Only allows $2000 maximum annual contribution per child (which may not meet everyone’s goal).
2. Has income qualification; that is, you may not contribute to an Education IRA in a year that you make more than $110,000 as an individual or $220,000 as a joint couple.
3. Funds must be withdrawn or rolled to another family member when the beneficiary reaches age 30 or the funds will be taxed and hit with a 10% penalty.
4. Could be counted as assets in the child’s name when applying for financial aid.

#3. Roth IRA. 

Wait a minute, isn’t a Roth IRA for retirement? Yes, it is. But there are a few reasons that allow the 10% early withdrawal penalty to be waived, including college expenses for yourself, spouse, child, or grandchild.

PROS:

1. You can contribute 100% of earned income up to a maximum of $5,500 annually ($6,500 if age 55+).
2. Inexpensive to set up and manage.
3. If your child does not need assistance with college expenses, funds can stay in the Roth IRA for retirement.

CONS:

1. Only the contributions into the Roth can be withdrawn tax-free. The earnings on the investments will still be taxed until you reach age 59 1/2. Ex: you contribute $50,000 over the years and the Roth now has grown to $75,000. Only the $50,000 can be withdrawn tax-free.
2. You may not contribute to a Roth IRA in a year that you make more than $131,000 as an individual or $193,000 as a joint couple (these limits are capable of changing every year).

#2. Universal Life Insurance.

Not your typical investment vehicle for college savings. This investment vehicle can be an attractive strategy for those who are looking for additional benefits, in addition to providing life insurance coverage for you or your child.

PROS:

1. The accumulated cash value in the account stays in the control of the policy owner (Parent) and can be utilized for any reason, not just college expenses.
2. You may be able to contribute more than both the ESA and the Roth IRA.
3. Could continue to provide insurance coverage for your child long after college at preferred rates.
4. You may withdraw directly from the principal or cost basis without paying taxes, and you can tap into earnings by taking out an extremely low-interest loan from the account.
5. Will not count against the child’s or the parent’s financial aid picture.

CONS:

1. Comes with some extra costs of paying for mortality and expenses fees for the insurance.
2. More challenging to set up and will most likely have to use an advisor to set up properly.
3. Could have limited investment options to choose from.

#1. 529 College Savings Plan.

Just like the ESA, your after-tax contributions grow tax-deferred and may be withdrawn tax-free for k-12 expenses in addition to college expenses.

PROS:

1. Depending on which state you live in, you may be able to receive a further tax deduction at the state level on your contributions.
2. Contribution limits are set by the states and can be as high as $380,000. There may be gift tax consequences for more than $14,000 gifted per year if single or $28,000 from a married couple filing jointly. But you can fund up to 5 years of that gifting amount in the first year (Also note, there is currently a $5 million lifetime gift exemption per individual $10 million joint, so most won’t have to worry about gift tax).
3. The account owner (usually a parent) maintains control of the assets. The assets can grow in perpetuity. The account owner can change beneficiaries to extended family or use for higher education for themselves.
4. If a child gets a scholarship, the 10% penalty is waived for withdrawing the principal for non-education purposes, however, the growth earned would still be subject to federal and state income tax.
5. Easy and inexpensive to set up and manage.
6. Little effect on the child’s ability to apply for financial aid as assets in name of the account owner.

CONS:

1. Some plans may only offer very limited choices or only age-based allocation, which could limit your ability to achieve the returns you are expecting or control the downside risk during downturns like in 2008. (You will have to do your homework on which plan works best for you.)

(1). 2011–12 National Postsecondary Student Aid Study

#Collegeplanning #Financialplanning