Last week, we examined how decisions play an important role in paying for college. This week, we look at ways to pay for college. While parents usually assume the responsibility of funding their kids’ education, kids can also be involved in saving for their own education. Let’s look at the ways to save and pay for college.
One of the most popular ways to save for college is through a 529 plan. Named after Section 529 of the IRS tax code, you guessed it! There are tax benefits to saving in this type of account. The main tax benefits are that your savings grow tax-deferred, and your withdrawals are tax-free if used for qualified education expenses. Depending on the state you live in, contributions to the 529 plan may be deductible for state tax purposes, but are not tax-deductible on federal taxes. Not all states offer a 529 plan, but you can still open a 529 plan offered by another state. Keep in mind that a 529 plan is like the flower pot we reference time and time again. You choose the “seed” investments that go in the account, so you can gain or lose money, depending on how your investments perform. We’ll take a deeper dive into the 529 plan in the future, but there is a good introduction provided by the U.S. Securities and Exchange Commission.
Prepaid Tuition Plans
We won’t spend much time on Prepaid Tuition Plans because only a few states offer this option. If you live in a state that offers this option, the plan allows you to buy future credits at today’s tuition prices. As an example, if one course credit costs $1,000 today, but doubles to $2,000 by the time you go to college, you essentially got a 50% discount on education. Think of it as locking in tuition at today’s prices. The downside to this plan is that you are pretty much stuck with choosing a participating in-state college. Although your state’s Prepaid Tuition Plan may offer some portability to other in-state and out-of-state colleges, the penalties and reduced benefits of choosing non-participating colleges make other savings options more viable.
If you want the most freedom and flexibility, then a non-qualified account will be your best choice for college savings. This can be through a bank savings account or a brokerage account (which allows for investments beyond cash). Like a 529 plan, your savings can go up or down, based on what you invest in. Unlike a 529 plan, your earnings don’t receive any tax benefits, so taxes take a bigger chunk out of savings. However, you can use the money however you choose, even if it’s not for college. The previous options are not as forgiving when withdrawing money for other non-education expenses, charging an extra 10% withdrawal penalty, in addition to taxes on withdrawals.
We mentioned last week that scholarships are worth a try, since they are essentially free money that does not have to be paid back. Grants are also free money, but not everyone qualifies for grants because they are based on a family’s financial need. Another need-based option is work-study, where students are given a part-time job to earn money while attending school. Finally, if there is not enough money to pay for college upfront, you can borrow money in the form of student loans. While you are required to pay back the money with interest, the interest rates on student loans are relatively low compared to other types of loans, and you usually have a grace period after graduation before repayment begins. Both parents and children need to be involved when it comes to financial aid – scholarships, grants, work-study and loans. The other options begin years in advance, sometimes as early as birth, so parents typically shoulder the responsibility of saving. On the other hand, financial aid planning happens the year before college, so children have reached an age where they can and should be involved in financial decisions.
As a reminder, college decisions are just as important as saving for college. That’s why both parents and children need to be educated (excuse the pun!) when it comes to paying for college!
Homework: Students, test your business skills by giving parents a presentation on 3 different colleges and how you would pay for each one. Whatever format you use to present, be prepared for Q&A at the end!