Saving and Budgeting for College

Posted by Bonnie on August 29th, 2008 filed in Budgeting, Saving and Investing

Whether you have a newborn baby or a teenager, you might be wondering, how am I going to pay for college? We have had several questions asked about how to save and budget for college expenses. So I will cover several of the alternatives.

There are many ways to save for college including a prepaid plan, a 529, Coverdell, bonds, or a regular savings account.

Prepaid College Plan / 529
Advantages	Disadvantages
Locks in college cost at today’s prices No income restrictions High contribution limits Anyone can establish a 529 account Plan holder determines how money is used and can change the beneficiary Earnings in 529 plans are federal income tax deferred Withdrawals used for qualified higher education expenses are also free of federal income tax It’s possible to contribute substantial amounts to an account without incurring any gift tax Won’t affect use of Hope Scholarships and Lifetime Learning Credits	May only be good for the state you purchase it in (Texas’ 529 is good for any state) There may be tax consequences if the beneficiary is changed to a lower generation Nonqualified withdrawals are subject to ordinary federal and any applicable state income tax and an additional 10% federal tax Assets may only be reallocated once per calendar year or upon a change in beneficiary Not insured or guaranteed by FDIC
Coverdell Education Savings Account (ESA)
Advantages	Disadvantages
Can be applied to any accredited school grade K-12 or college Can be used for tuition, fees, books, supplies, room and board, and equipment Earnings are federal and state income tax deferred Withdrawals for qualified education expenses are tax free The value of the account is removed from the account owner’s taxable estate Other family members can set up and contribute Doesn’t limit your contributions to retirement plans	Limit of $2,000 investment per year per child Contributions are not tax deductible Adjusted gross income must be less than $190,000 if married or $95,000 if single Contributions for students 18 or older are not allowed except for special needs students Tax penalty of 10% on nonqualified withdrawals Withdrawals must be made by student’s 30th birthday Considered student assets for financial aid purposes
UGMA/UTMA Uniform Gifts or Transfers to Minors Act
Advantages	Disadvantages
Allows custodian to transfer or gift assets to a minor without setting up a trust No maximum investment Can contribute up to $11,000 per child each year free of gift tax Any expense beyond basic support of the child is permissible No income restriction Investment flexibility Other family members can contribute Tax credit is not affected Money can be used at any time for the benefit of the child	Child gains investment decision control at age of majority Taxable, some at student’s rate Value of account is part of custodian’s estate if custodian dies before child takes control Investment earnings are usually taxed at child’s rate Irrevocable gift and may not be transferred to anyone else Considered student assets for financial aid purposes

Should I Pay the Full Cost of My Child’s College?

You probably can’t afford to pay your child’s full college tuition, and room and board, and save for your retirement, unless you are rich, or your child is still very young. For sticker shock, go to this link and look at the 529 College Cost Calculator. I believe this calculator is showing the whole cost of attending college, because if you start saving $66 per month when your child is born, and you can get 5% interest on it, you will have approximately $20,000 by the time your child is a freshman. The white paper on “College or Retirement” is worth looking at also.

The best plan is for your child to make good grades in school and apply for scholarships. Students can start applying for scholarships while they are in middle school. When they are college age and have been accepted at a college, they can apply for school specific scholarships. Many states now have different level scholarships that are offered by the state. If you have a 529 plan, and your child qualifies for a scholarship, the 529 plan can be used for qualified education costs that the scholarship does not cover, like books and fees.

Join Upromise for freeand let hundreds of America’s leading companies help you save for college. Even though you have to use certain lenders to cash in the money saved, it is free money to you because it is contributed into your account based on products that you buy. If you buy any clothes or household goods online, you would log in to your UPromise account first and then go to the online store. Some restaurants participate in the program also. These purchases will add a lot more money into your account then using your card just for groceries will.

Financing College and Your Retirement

If financing your child’s college will include college loans, you could still be paying for your child’s college when it is time to retire. So both goals of college and retirement need to be addressed together in a single effective strategy.

Your first priority should be contributing to your tax-advantaged retirement savings plan. Why? Unlike college, there are no grants, scholarships or loans for financing your later years. Tax sheltered contributions give an immediate reduction in your current income taxes and you can get tax-deferred growth of investment earnings. Many state colleges, universities and even some private colleges exclude retirement assets from consideration when assessing need.

If you will be 59 1/2 when your child is in college, you’ll have penalty-free access to the money in your tax-advantaged savings plan. Funds in a traditional or Roth IRA may be withdrawn for higher education expenses without penalty even before you are 59 1/2, but they may be taxed as income. It is much better though, to have other money set aside for higher education and keep your retirement nest egg growing for your own future.

The planning and budgeting you do today will have a large impact on what your financial future holds. We will be helping you get started if you haven’t already. We will be launching our easy budgeting tool at the end of September, so stay tuned.

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