College tuition continues to rise, with few signs of slowing down in the near future. If you plan to help your children with the cost of attending college, it’s best to start saving when they are young and time is on your side. Creating a strategy today may help you reduce the stress and financial burden as your child gets closer to his or her college years. Here are some strategies to help tackle this important financial goal.
Fund a 529 plan
529 plans, named after Section 529 of the Internal Revenue Code, are one of the most popular investment vehicles American families use to save for college. These plans are specifically designed to help people save for higher education expenses, and the funds can be applied to most accredited colleges, graduate programs, professional and trade schools. For federal income tax purposes, your contributions to a 529 plan are not tax deductible; however your earnings are permitted to grow tax free (note, state benefits may be available). Additionally, you will not be taxed at the federal level (and in most cases, at the state level) if the money is eventually withdrawn and applied to eligible higher education expenses.
As you consider if a 529 plan is right for your family, consider the following tips for funding one of these savings accounts:
1. Calculate the amount of education expenses needed.
First, decide how much you and your child would each like to contribute to his or her education, and estimate college expenses accordingly. Savings put aside in a 529 plan can be for tuition, school fees, room and board, internet access, required technology (i.e. a laptop or printer) and textbooks. Be sure to include the cost of these items when calculating the amount you need to save. Keep in mind that it is possible to overfund a 529 plan. If you save more money in the plan than what you use for your child’s education, you will be taxed on the earnings and penalized for spending the money on non-educational expenses.
2. Save automatically and increase the amount over time.
Most 529 plans make it easy to consistently save by allowing you to make automated contributions. As your financial priorities change, such as when you’re no longer paying for daycare or your spouse goes back to work, consider boosting your monthly savings. Don’t neglect your own financial future, however. Contributions to your own retirement plan should take priority over saving for a child’s college tuition.
3. Increase savings with gifts from friends or family.
When your child is young, apply monetary holiday or birthday gifts from friends and family to your college savings fund. A small gift today will be given the chance to grow, and could make a big difference in the total you have available when your child is ready for college. If a grandparent would like to contribute regularly, he or she may establish their own 529 plan with the grandchild as the beneficiary. The only drawback is that when these assets are withdrawn, they may be considered reportable income to the grandchild in the Free Application for Federal Student Aid (FAFSA) calculation, potentially reducing your child’s eligibility for need-based financial aid.
4. Select the appropriate investment option.
There are a variety of investment options available, as many states and educational institutions offer 529 plans. While you may choose a plan in another state, check to see if your state offers any tax deductions, credits or benefits for residents before doing so. Ultimately be sure to choose a plan that offers the right mix of investments for your time horizon and risk tolerance.
5. Create a strategy to save for multiple children.
Because each 529 plan can only have one beneficiary, you need to be thoughtful about how you use this type of plan for each child’s college savings. If you will have multiple children in college at the same time, it may make sense to establish a separate account for each child. If there’s excess money after your eldest child finishes college, you may transfer the balance from his or her 529 plan into one or more other plans penalty-free. However, if there is an age gap between your children, you can reassign the beneficiary of the account to your second child after the original beneficiary no longer needs tuition assistance. (Gift tax consequences may apply, so review your strategy with your tax advisor.)
Additional college savings options
While 529 plans are the most common way to save for college, they’re not the only option. Other tax-advantaged savings options parents use include Coverdell education savings accounts, Uniform Transfers to Minors Act (UTMA) accounts, Uniforms Gifts to Minors Act (UGMA) accounts or tax-exempt savings bonds. Families also have the option to save using a taxable account.
Keep in mind that there are advantages and disadvantages to each college savings option, and each option may impact your current financial situation and your child’s eligibility for financial aid differently. If you want a second opinion on which option is best for your family, consult with a financial advisor. A financial advisor will look at your unique set of circumstances, and together you can create a financial plan that includes saving for future college expenses.