8 Ways to Start Saving For Your College Education
According to the College Board, the cost of attending an in-state public college has increased on average 2.2%, while private schools have increased 3.45% per year over the rate of inflation from 2009 to 20191. The best strategy you can use to be prepared for this reality is to start saving as early as you can — we can help you put together a plan to help you start saving now, so when it comes time for college you can focus more on applications than tuition.
1. U.S. Savings Bonds
Series EE and Series I U.S. Savings Bonds, which are available from the U.S. Treasury Department, offer a low-risk and modest-return investment for college saving. And if the bonds are used to pay for qualified college expenses, the interest earned is generally free of federal, state, and local taxes. If purchased early in the student's life, they provide a safe, guaranteed return once college rolls around.
2. Custodial Accounts
The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) are laws that allows a donor to give money or assets to a minor without needing to set up a trust fund. There are no contribution limits, and anyone can contribute. The earnings from the custodial account are taxed under the minor’s name, and the account is considered an asset when the student applies for financial aid. There is added flexibility because custodian can use the funds for anything as long as it is for the benefit of the minor. However, once the minor gains full rights to the account once they reach the stated age, and they can then use the money for whatever they want.
3. Mutual Funds
There are no restrictions to how much you can invest in mutual funds or how the proceeds from mutual funds are spent. With thousands of funds to choose from, we have a variety of investment options that will potentially yield a higher return that can be put toward our children’s college. You should remember, though, that the amounts showing on the reports will be taken into account when calculating financial aid, even if you sell shares to assist with college costs. You are also responsible for reporting the earnings on our income taxes and for paying any capital gains on the distributed shares.
4. 529 Plans
529 plan is a college savings plan that offers tax and financial aid benefits. 529 plans may also be used to save and invest for K-12 tuition in addition to college costs. The federal taxes on the earnings in a 529 Plan are waived if the money is used for qualifying higher education expenses. You have two 529 plan strategies to work with:
►College Savings Plans receive contributions of after-tax dollars and that money is invested in mutual funds or other investment opportunities. Like other forms of investing, the balance of the account increases and decreases based on the type of investments made.
►Pre-Paid Tuition Plans allow for in-state public college costs to be pre-paid. While this plan can be used to pay for out-of-state colleges and private institutions, many states who offer Pre-Paid Tuition Plans offer tax incentives when the money is used for in-state public colleges.
Many states offer 529 plan strategies, but you aren’t limited to your own state’s plans. You can also use 529 plans to pay for out-of-state colleges regardless of where you live or which state 529 plan you participate in. This type of plan is also beneficial when applying for financial aid because the plan is counted as parent assets and withdrawn funds do not need to be reported when the money is used for college expenses.
5. Roth IRA
Most of us don’t realize that having a Roth IRA can be a college savings plan option. Initial contributions to this investment account can be withdrawn for any reason, and the standard 10 percent early withdrawal penalty is waived if using the money for qualified higher education. However once those are exhausted there could be income tax and potentially penalties, plus you will not be able to return fund after withdrawing them. The total value of a Roth IRA is not counted as an asset when calculating financial aid, but the amount withdrawn does count as income for the base year. Before making any decisions, speak with your tax advisor.
6. Coverdell Education Savings Account
Formerly known as the Education IRA, the Coverdell Education Savings Account (Coverdell ESA) is similar to a 529 Plan but is more restrictive. You can only invest up to $2,000 per student per year in a Coverdell ESA account, and all contributions must be made before the student turns 18. The proceeds from the account must be used before the beneficiary turns 30. You must also include the Coverdell ESA as a parent asset on the FAFSA application.
7. Whole Life Insurance
Another option many often don’t consider as an option for college savings plan is the supplemental use of whole life insurance. Whole life insurance owned by a minor will lock in their insurable interest for life, but there are many other benefits to consider. With a whole life insurance policy, part of the premium is set aside into a “cash value” account. Plus, the cash value doesn’t currently factor into college financial aid calculation and the policy accumulates on a tax-deferred basis at a guaranteed rate of return. As long as the premiums continue to be paid, the cash value of the policy grows. You can withdraw from or borrow against this cash value amount. Although you do not have to pay back the money, it does reduce the amount of money paid out upon death if not repaid.
8. Irrevocable Trusts
You can also create irrevocable trust during your life with your children (or grandchildren or others) as beneficiary. This removes assets from your estate and can be directed towards specific goals including education. There are a number of trust structures that can be used, from the standard basic irrevocable trust to ones that combine gifting to heirs with donating to charity. Assets so gifted are then beyond your control, so exercise caution in setting up trusts and contributing assets. Consult with your estate planning attorney and Lenox advisor.
As parents and grandparents, we often struggle with the best way to start a college fund for our children or grandchildren while taking care of our own needs. These options are just a few ways to reduce cost of higher education as you prepare for their future. To help you decide which option makes sense for you and your family, contact your Lenox Advisor.
1 Research.Collegeboard.Org, 2019, https://research.collegeboard.org/pdf/trends-college-pricing-2019-full-report.pdf.
The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Lenox Advisor, Inc., its employees, or representatives are not authorized to give legal or tax advice. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal tax or legal counsel.