Hey guys! I want to share this guest post by Jacob, blogger and content creator @DollarDiligence. Jacob is working to expand his writing portfolio, while inspiring you to become financially free. Today we’re talking about planning our education expenses.
Feel free to check out more about managing money over at DollarDiligence.com
College is costly, but with an early start and prudent planning, it can be reasonably affordable. Much rests on the college your child attends and the financial aid offered to you. The trick is to start planning while your child is still young and to learn about the most efficient methods to pay future college expenses.
A Snapshot of College Costs
The College Board compiles the average annual amounts for tuition, fees, room and board, categorized by school location and type. Undergraduate programs in your state will, on average, be less costly than out of state ones. Not surprisingly, two year programs cost less than four year ones, and public schools charge less than private schools.
The average 2016-2017 one-year costs for net tuition and fees were at public in-state four-year colleges was $9,650, whereas the out-of-state number was $24,930. At four-year private institutions, the average costs were $33,480. Room and board adds on average more than $10,000 a year.
Strategies for Paying College Costs
You can finance your child’s education using your portfolio of investments, but you might prefer to cover education expenses via tax-favored programs.
Section 529 Plans
Section 529 accounts are tax-free as long as you apply distributions to qualified college costs. The two major plan types are:
1. Prepaid Tuition Plans: These are state-sponsored accounts in which you pay in advance for tuition credits at a qualified educational institution within the state, frequently at a discounted rate. The state invests the money it receives– you simply are buying guaranteed credits. There is also a national program, the Independent 529 Plan, that applies to about 300 educational institutions throughout the country.
2. College Savings Plans: These are investment accounts in which you control contributions that grow tax-deferred. Cash from these plans is distributed tax-free when used to cover qualified education costs, including fees, tuition, room, board, books and supplies. The amount you accumulate for your child hinges on the plan’s returns. These plans are offered by mutual fund companies that invest the funds for your benefit.
529 Plan contributions that exceed the yearly federal gift-tax exemption ($14,000 in 2017) may be subject to the gift tax, although you can sidestep the tax if you invoke your lifetime gift tax exemption — $5.49 million per individual in 2017. A special codicil allows you to contribute a lump sum amount equivalent to five-years-worth ($70,000) of the yearly gift-tax exemption and then use the exemptions over the subsequent five years, penalty-free.
Coverdell Education Savings Accounts
Coverdell plans permit you to contribute as much as $2,000 annually. The money grows tax-deferred, and distributions for qualified education costs are tax-free. Contributions may be disallowed if your earnings exceed specified limits. Coverdell accounts don’t provide tax deductions for contributions. You must initiate a Coverdell account prior to the student’s 18th birthday, cannot add money after that date, and must distribute all the money as of the student’s 30th birthday. You can also use Coverdell accounts to pay private school expenses for grades K through 12.
Savings Bonds for Education
The interest income from Series I and Series EE U.S. Savings Bonds is tax-free when you cash in the bonds and apply the proceeds to pay for qualified educational expenses at eligible schools – i.e. schools that can receive money from federal student aid programs.
This tax break is only available if your income doesn’t exceed specified thresholds. The bonds must be issued in the parent’s name(s), not the child’s. You can purchase up to $10,000 in Savings Bonds annually. The disadvantage of this method for financing education costs is that savings bonds are currently paying puny interest.
Aid Programs
Students often receive scholarships and grants to help pay for post-secondary education. This is tax-free money, and it decreases the money parents must cough up to help pay education expenses. Scholarships are merit-based, whereas grants are based on need. Aid is offered by the federal government, state governments, schools, and non-profit or private organizations.
Students can apply for federal student aid by submitting a Free Application for Federal Student Aid (FAFSA). Students and families must submit the FAFSA to be considered for federal student loan programs. The form elicits financial data and sources of student assistance.
The federal government distributes grants based on specific eligibility criteria. Parents can employ various strategies to reduce their expected family contributions, including:
• Postponing Social Security benefits, if applicable
• Postponing capital gains on stocks, bonds and other investments
• Taking capital losses
• Earning rental income, which is frequently excluded from expected family contributions because depreciation can eliminate the profit (on paper) of property rentals
• Not making tax-deductible contributions to retirement plans, because they are added back for purposes of calculating aid – that’s a bad deal
• Owning a small business, because its value is excluded when computing aid
The federal government also provides two programs, the Lifetime Learning Credit and the American Opportunity Credit, that permit you to annually claim $2,000 – $2,500 per student for qualified educational costs.
Student Loans
Student loans assist parents by decreasing the money they feel they must contribute to their children’s education savings. Some parents may choose to help their children repay the student loans as they come due. This can be a reasonable strategy for parents who anticipate being richer in the future than they currently are.
In general, the vast majority of private student loans require the parent to act as a cosigner. Many parents will find themselves on the hook for student loan debt even after their child graduates from college. Parents need to consider the pros vs. cons of saving more money early, versus the potential impact of student debt on their credit and retirement in the future.
Moreover, parents can ask for a PLUS federal student loan, as long as their children are undergraduates who go to a post-secondary school at least half-time. The parents, not the students, are responsible for repaying PLUS loans. Students apply for federal student loans via the FAFSA.
Thanks Jacob for all the college information! I know my husband and I already decided we will NOT be taking on loans for our kids’ education. We’re really pushing on them to earn scholarships and be wise about using up all the options before signing for a student loan.
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