Every year, college expenses rise by about 6%. This can be alarming news to people who are just starting a family; the cost of a degree may be outrageous by the time their children reach college. Like retirement savings, there are different ways to save money for tuition bills, and it’s best to start saving as early as you can. The key is picking a savings plan that makes sense for your family and the educational route you think your children will want to take.
One of the best ways to save for college is by using a permanent life insurance policy. You might think life insurance policies just cover death benefits, but when you pay premiums, only a portion of that money goes towards death benefits. The remainder is held in a cash-value account, and you are allowed to borrow money against it. The benefits are two-fold; you gain the peace of mind that comes with having a life insurance policy, and you are not limited to borrowing the money exclusively for college. If your child does not attend college, money can be borrowed for a downpayment on a home, or it can be used to start a business instead. Because you are taking a loan, as opposed to a distribution, you do not have to pay taxes on the funds you withdraw. But, it is important to keep in mind that if you don’t pay back the money, the loan amount will be deducted from the policy’s death benefit. It can also take a long time to build up the cash value needed for tuition, so it’s best to purchase the policy when your children are young.
Another option is to start a 529 savings plan for your children. The 529 plan gives anyone who wants to contribute (parents, grandparents, etc.) the opportunity to build an education savings account tax-free, as long as the money is used directly for undergraduate or graduate expenses at a 2 or 4-year college in the United States. Anyone can open the plan or contribute to an existing one. The parent or legal guardian maintains control over the account, and if the designated child decides not to attend college, a new beneficiary may be named. There are a few things to bear in mind, though: if you don’t transfer the savings to a beneficiary, and you don’t use the money for qualifying education expenses, you could be hit with a steep tax bill. A 529 plan is also counted as a parental asset, and could impact the child’s ability to qualify for financial aid or scholarships. And finally, it’s important to understand that 529 savings plans are tied to the stock market, so while that could lead to higher rewards, it also means greater risk.
Another viable option for saving towards college is to open a Roth IRA. We’ve discussed Roth IRA’s before and the role they play in retirement, but these savings plans can also be used towards education. After 5 years, money from the Roth account may be withdrawn tax and penalty free to be used for education-related expenses. The greatest benefit of the Roth IRA is that if you don’t use the money for college, the plan can be continued on as a savings plan for retirement, which you don’t want to lose sight of amidst the college planning.
Similar to the 529 savings is the Coverdell ESA. Money put into the ESA grows tax-free, and cannot be taxed if withdrawals are for educational purposes. The Coverdell, however, has lower contribution maximums, which limits the amount you can save, and anything over the maximum amount allowed is subject to a 6% excise tax. Perks to the Coverdell include it being viewed as a parental asset when it comes to applying for financial aid, and in some instances, funds from the Coverdell may also be used toward K-12 expenses. If you open a Coverdell ESA for your child and later decide it’s not the best option for your family, you can transfer the money to a 529 plan as long as the beneficiary remains the same.
Other options for college savings certainly exist, but many come with heavy tax penalties or could be tricky to navigate. Parents should keep in mind that while it’s smart to save for college, there are many ways to foot education bills later and it’s crucial to keep your own financial goals in mind. While no one wants to have their child end up buried in student debt, when it comes to retirement, there are no loans available, so it’s important to invest wisely and be careful not to invest all your money in college savings.
For help planning for future college expenses, contact the experts at The Hopman Group and let us guide you through saving for your children while keeping your own financial goals in mind.