What Are The Best Vehicles To Save For College?
A college education can be one of the most important investments you ever make. But the benefits of your child’s increased earning power and expanded horizons come at a price — college is expensive. Many families finance a college education with a combination of resources, but your savings are the cornerstone of any successful college funding plan. So it’s important to start saving as soon as you can.
For 2017/2018, average costs for tuition, fees, room, and board are:
- $20,770 — public college
- $46,950 — private college (many private colleges cost substantially more)
Source: College Board, Trends in College Pricing 2017
Where should you put your college savings?
There are many options to choose from:
- 529 plans
- Coverdell Education Savings Accounts
- Roth IRAs
- Mutual funds, stocks
- Savings accounts, money market funds, CDs (These may be a good place to park your short-term savings, but their relatively low rates of return make it hard to keep up with college inflation)
Choosing the right college savings options involves taking into account your income, time horizon, and risk tolerance, along with your personal preferences on issues like tax benefits, investment control, and flexibility on use of funds. The following table compares some common college savings options.
| 529 plans | Coverdell ESAs | Roth IRAs | Mutual funds
& stocks |
|
| Open to anyone | Yes | No | No | Yes |
| High or no contribution limit | Yes | No | No | Yes |
| Full investment control | No | Yes | Yes | Yes |
| Tax-free earnings | Yes* | Yes* | Yes** | No |
| Flexibility | No | No | Yes | Yes |
| Counted for financial aid purposes | Yes | Yes | No | Yes |
* Earnings are tax-free only if the funds are used to pay the beneficiary’s qualified education expenses. If the funds are used for a different purpose, then earnings are taxed at the income tax rate of the person making the withdrawal and are also subject to a 10% federal penalty.
** Earnings are tax-free if the withdrawal is made after age 59½ and a five-year holding period is met; the funds do not need to be used for college to be tax-free.
When saving for college, you should consider tax-advantaged strategies. 529 plans, Coverdell Education Savings Accounts, and Roth IRAs offer federal tax advantages when used to pay for college, as noted in the table above. Another tax advantage is the Education Savings Account Contribution Credit (or Subtraction) provided by the State of Minnesota beginning in 2017. Minnesota allows a credit of 50% of contributions made to a 529 plan during the year, up to a maximum of $500 – subject to phase-outs based on income limitations. You can claim this credit regardless of the owner or the beneficiary of the account. If you are phased out of the credit, you can be eligible for up to a $3,000 subtraction for your contributions.
What If I Want To Save For Someone Else’s College Education? (i.e. What savings vehicles are best?)
We often see that grandparents, aunts and uncles, godparents, etc. would like to contribute to college education funding for a loved one. This is a great way to increase the savings for the college financial burden. Any of the vehicles noted in the first question can be used. However, when utilizing a 529 plan or Coverdell, you would need to choose a beneficiary of the funds, because these investments are designated specifically for education costs. The beneficiary on these accounts can be changed at any time.
Are There Limits I Should Borrow For College?
When you file the FAFSA (Free Application for Federal Student Aid), your child becomes eligible for certain federal loans. Some of these loans are based on financial need, but one loan (the Direct Unsubsidized Loan) is open to any student, regardless of need. All loans have annual borrowing limits. The student takes out the loan in his or her name and is responsible for paying it back. In addition, parents with good credit histories can take out a federal PLUS Loan for up to the full cost of their child’s education. Beyond this, a parent might decide to co-sign on a private student loan, with the student as primary borrower. If you co-sign on a loan and your child can’t pay back the loan after graduation, then you are on the hook.
It is important to look at your individual financial situation. Students and parents who borrow too much for college could end up with a considerable debt burden that can last for years after graduation. The key is to save as much as you can before college to limit the amount you might need to borrow come college time.
If you have questions relating to how to save for your student, don’t hesitate to contact one of our experts today!
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