As parents, one of our greatest concerns is how we will pay for our child’s higher education, especially when we realize that financing education will cost at least $100,000 for each of our children, and that is just the college or university fees.
While we hope to get help from scholarships, students loans, and financial aid, we still need to find much of that money ourselves. Obviously the sooner we start preparing for this the better, though the important thing to bear in mind is that it is an achievable goal if we are willing to make some sacrifices.
The first thing that we need is a plan, and that plan should detail the major sources of finance, which are savings, tax relief, and financial aid. Let’s look at them all in some detail:
The sooner you start saving the better. Just investing a modest sum, say $250, every month for eighteen years at 7 percent would more than exceed your savings goal of $100,000. However if you had only 10 years to save, you would need to double that amount to $500 a month to achieve the same goal.
How to save is as important as how much to save. The best way of saving for long term growth is in the stock market, though in order to cope with its volatility you should view it over a ten year term. It is the best way of saving if your child is under 11.
As the stock market is volatile, it is not a good idea to leave your money there after your child turns 14; then it is better to save in safer investments, for instance short term bonds and other safe investment funds.
Fortunately there are some valuable tax breaks available for people who are saving for higher education. These are the Qualified Tuition Program, the Prepaid Tuition Plan, the Coverdell Education Savings Account, the Uniform Gift to Minors Act (UGMA), and U.S. Savings bonds.
Qualified Tuition Program
This is also known as the state-sponsored 529 Savings Plan. Each state has one and although there are some differences between them in essence they all offer tax free interest on savings that are used to cover educational expenses with no cap on tax free income.
They are available to every family and a single child can be the beneficiary of multiple accounts, for instance from parents, grandparents and other family members. If the named beneficiary does not use the funds, then they can be used by a close relative.
These funds are professionally managed and combine aggressive and conservative strategies depending on the child’s age.
Prepaid Tuition Plan
Also known as the prepaid 529 plan, this gives you the opportunity to pay college fees as a discounted rate. The advantage of this kind of plan is that you pay tuition fees at today’s prices. For instance if you pay the current cost of a semester now, then you are guaranteed that it will cover the cost of a semester even fifteen years in the future, so they are essentially risk free.
The drawbacks are that they have an adverse effect on the financial aid you might otherwise be entitled to, they lack the flexibility of the Qualified Tuition Program, and if they are not used then the capital is returned but without interest and with the possibility of a cancellation fee.
Coverdell Education Savings Account
These accounts can be opened in most banks. You are able to invest up to $2,000 into the account and invest it in any way you wish. Although there isn’t a tax break on your contributions there is no tax on withdrawals used to fund education and the earnings accrue grow free of federal income tax. These provide an ideal complementary investment vehicle, though it is only available for certain income groups. You can read more about these accounts here.
Uniform Gifts to Minors Act
This act allows parents to open and control accounts for their children until they are 18 (or in some states 21) and provide fully flexible investment options, though they have limited tax breaks which depend on specific circumstance. They are still more tax efficient than ordinary savings accounts and the money doesn’t have to be spent on education; as it has been gifted it belongs to the child. They also have a negative impact on financial aid.
U.S. Savings Bonds
These can provide a reasonable rate of return and the interest earned is not subject to state taxes, though federal tax is payable on maturity or redemption if the funds are used for purposes other than education. You can also elect to recognize the interest income annually on the bonds. This is a good planning opportunity for children with low incomes.
Financial Aid and Higher Education
Around fifty percent of college students working towards degrees receive some form of financial aid.
It is necessary to apply for Federal Student Aid in January of the year your child starts college. The current scheme requires a parental contribution of between a quarter and a half of income plus six percent of assets and a student contribution of twenty percent of personal assets, so it’s better to keep assets in your name rather than your child’s name. Once the amounts have been determined the college will make an offer made up of some combination of grants, loans and scholarships to cover the remaining costs and fees.
Various federal grants are available depending on your financial circumstances and scholarships are usually awarded to outstanding students. There are various federal student loan packages with low interest rates and extended repayment periods. Parental loans are also available.
If fees are being paid out of taxable income, then tax credits may be available depending on your income, though the rules are quite complex and subject to change. Nevertheless, they are certainly worth pursuing as they can be very valuable – particularly for families in the lower income brackets.
Conclusions about higher education
Although planning how to pay for your child’s higher education requires some thought and work, it is certainly worth the effort, and the earlier you start to do so the easier it will be to find the necessary funds without getting into significant debt, so why not start today?