My oldest daughter, Lauren, is 9 years old and we talk about money regularly. These are not sit-down lectures where she struggles to stay awake, but every day conversations where we dialogue with one another, so I can instill healthy money habits and beliefs in her. One question I regularly ask her is, “Why is important to get good grades?”
Her answer? “So I can get into a good college and get a good job.”
This answer didn’t happen by chance. We frequently talk about college and the opportunities it represents, and I also make sure she understands attending college is something she has to earn.
College Savings Investment Options
While Lauren is busy hitting the books, I am busy saving money to help finance her college education, which many of you are doing as well, so let’s take a look at some of the different college-savings vehicles available.
Congress created 529 plans in 1996 and they are qualified tuition programs or a college savings vehicle with federal tax advantages. There are two types: college savings plans and prepaid tuition plans. The IRS has a great question and answer guide to 529 plans, which you can find here.
Advantages: They are flexible, which helps when you don’t know exactly how much money you need to save for education. For example; my oldest daughter is 9 and my youngest is 7. I have overfunded my oldest daughter’s account, not because I think she is smarter but because she will be the first child who may attend college. If she does receive scholarships/grants or decides not to go to college, I can change the beneficiary to my youngest daughter. If they both graduate from college and there is still money left in their 529 Plans, I can use it for my grandchildren’s education, or use the money to go back to school for my PhD!
Like most tax advantage vehicles, there are lots of moving parts, so please read through the IRS Q&A before investing. Be aware there is investment risk involved. You should sit down with your financial advisor and walk through the investments with your risk tolerance and timeframe in mind. There are fees and expenses with 529 Plans and penalties for non-qualified withdrawals.
A Coverdell ESA is a tax-advantaged savings vehicle that lets you save money for qualified education expenses of a named beneficiary. Qualified education expenses include colleges expenses and certain elementary and secondary school expenses (advantage to Coverdell, 529 Plans only allows qualified college expenses).
The annual contribution limit is $2000 per beneficiary, which is considerably less than you can contribute to most 529 plans. The other drawback is depending on your earned income for the year, your contribution amount may be gradually phased out. The age of the beneficiary also limits the use of a Coverdell ESA, so you cannot make contributions for anyone 18 or older.
You can find more information on Coverdell ESAs here.
UGMA/UTMA—Unified Gifts to Minors Account/Unified Trust to Minors Account
Before 1996 these were the most popular way to save for children’s education. They are a gift to a child, which then grows and is taxed at the child’s rate (referred to as the kiddie tax). Due to this tax advantage they became very popular.
Advantage: They are flexible. Unlike the 529 and Coverdell ESA savings plans, the money can be used however the child pleases. If they do not go to college, the money can used as a down payment for a home or to pay for a child’s medical expenses without penalties.
Disadvantage: In my opinion — ownership. This money becomes the child’s upon reaching the age of majority (18 or 21 depending on the state). I cannot tell you how many parents have begged me to not let their children know this money is available or theirs at 18 or 21. The reality is the account is legally the child’s (now a new adult) and they are the account owner. Another disadvantage is this money is in the child’s name, so when it comes to federal financial aid calculations, it is considered the child’s resources for college and can influence the amount they are eligible for.
BE AWARE: 529 Plans, Coverdell ESAs and UGMA/UTMAs are complex. There are many more details that cannot be covered in a blog post and may be very important to your personal situation, so please consult your financial advisor to discuss which option is right for you.
Other Ways to Save or Pay for College
Let’s take a closer look at some other options available and weigh their pros and cons.
I see two major mistakes that parents make in this area.
- Counting on the child winning a scholarship or grant and not saving for college (assuming parents want to help pay).
- Not finding every scholarship/grant available and applying for everything!
My husband spent hours applying for everything he could and won several scholarships and grants, ultimately only needing $5,000 in student loans, which he paid off within a year of graduation. This would have not been possible if he had not spend countless hours researching and applying for every grant and scholarship available to him.
I often hear parents say they will take a loan from their 401k since this is often the largest savings outside of their homes. There are many concerns I have with this. A couple considerations:
- Have you calculated how this loan and the repayment of this loan affects your cash flow and retirement plans?
- If you leave your current employer or are laid off, your loan is generally due in full or considered a distribution, which will be considered ordinary income and taxed (meaning you will have to pay taxes on that amount from other assets or cash flow). If you are under the age of 59 ½, there could be a 10% penalty as well!
Paying for College from Cash Flow
It is hard for most parents to pay for college from cash flow and there is usually a reason why you were not able to save for college in the first place. Promising your child that you will pay from cash flow is, in my opinion, a mistake. After you go through your budget and know how much you can safely contribute (without going into debt or falling short on other goals, such as retirement) then do so.
Some Final Thoughts
Please remember, there is no universal rule that requires you to pay for college. Many very successful people put themselves through college and lived to tell the tale. Let go of the guilt and show your love by helping them find every scholarship and grant available and apply for all of them. There is also nothing wrong with a child getting a job to help cover some of the costs themselves. And if they still need student loans, then help them create a plan to tackle that debt after graduation.
The Heavy Purse Store is now open! My new downloadable Money Club Workbooks are now on sale. Each workbook provides five targeted lessons to help you raise Financially Confident Kids. Please check them out in The Heavy Purse Store.
Photos courtesy of www.freedigitalphotos.net.