Paying for College
Tuition, textbooks and computers, oh my! It's hard to think of saving for college when little ones are small. But soon enough your teen will be researching colleges. To lessen future financial stress, start investing in a good college savings plan now. The sooner you save the faster compound interest will grow.
Estimate the Cost
The first step for smart savings is finding out how much college will cost in order to determine necessary savings. T. Rowe Price's free Internet College Investment Calculator estimates college expenses and determines the monthly contribution needed to meet your goal. Simply enter the year a child will begin college and a specific school, and the calculator will estimate the funds needed. Further, you can choose to see how potential 529 savings will grow over the years.
The name "529" isn't user-friendly, but higher-income families will want to remember it. 529s are state-sponsored college saving accounts, which offer tax-deferred growth and tax-free distributions for education expenses.
These accounts allow investment of larger sums than other education savings programs, many allowing $200,000 plus, and 529s have no income limits on investors. Benefactors (such as Grandma and Grandpa) can shelter up to $110,000 in one year without paying federal gift tax as long as no more contributions are made for the next five years.
"The potential savings when investing in a 529 are significant, particularly compared to investing in a taxable account," says Brian J. Lewbart, spokesman for T. Rowe Price Associates.
An analysis by T. Rowe Price shows that if a parent in the 27 percent tax bracket contributes $5,000 a year to a 529 for 18 years, the money for college expenses would equal about $219,500 or 19 percent more than with a taxable account. (Assuming a return of 8 percent and a state tax rate of 5 percent.)
It's important to realize 529s vary widely, and they differ from state to state. Variations include state tax deductions, contribution limits, residency requirements and more. Research a variety of 529s to find the best plan for your family or seek assistance from a financial advisor.
"Think about where your family is financially when deciding how much to invest in a 529," says John Feyche, CPA, manager for Zdonek & Wolowicz Accountancy Corporation in Torrance, Calif. Feyche cautions that 529 funds are counted as student resources and can reduce financial aid.
Families should also consider the need for liquid funds when deciding upon investment amounts. "Once funds are in a 529 they are committed to education and subject to tax and penalty if withdrawn for other purposes," he says.
Recently Feyche helped a divorced woman set up a college savings plan for her daughter. Some funds were invested in a 529, but the remaining funds were kept liquid in a money market account. "There was some concern the daughter might qualify for financial aid or the money market funds would be needed, and the woman wanted to see how things developed," he says. "She can add to the 529 later or access the money quickly if necessary."
Coverdale Education Savings Accounts are a good option if you don't have a lot of money to invest but many years until college funds are needed. These accounts allow investments of up to $2,000 per year per student.
Earnings grow tax-free as long as they are used for eligible expenses, which include higher education as well as elementary or secondary school (tuition, uniforms, transportation, etc.). Contributors must earn less than $110,000 for single filers and $220,000 for married couples. Coverdale ESAs are considered assets of a student and may affect financial aid.
Ready for Roth?
Roth IRAs (maximum contribution $3,000 per year) offer no tax deduction for contributions, but future earnings are sheltered from taxes. These accounts are a good option if you're saving for both retirement and college or if you will be older than 59 1/2 when withdrawing funds.
One advantage of Roth IRAs is the waived 10 percent early withdrawal penalty when funds are used for qualified higher-education expenses. But regular income tax applies for withdrawals prior to age 59 1/2. And not everyone can contribute. "Roth IRAs have income limitations," Feyche says. "Right now to make the maximum annual contribution singles must have an adjusted gross income of $95,000 or less and couples $150,000 or less."
Using Uniform Transfer to Minor's Accounts
These accounts allow minors to own stocks and bonds. "With a UTTM account, you're basically making a monetary gift to a minor," Feyche says. "If the child is under 14, the income is taxed at the parent's highest rate for income in excess of $1,500. But once the child is 14 (or over) funds are taxed at the child's own rate." A UTTM account can be opened at a bank, mutual fund or brokerage firm. Singles can contribute up to $11,000 per year and married couples $22,000 without gift tax (or $55,000 and $100,000 respectively if no additional contributions are made for five years).
The big downside to a UTTM account is that the child controls the assets at age 18. Funds that were earmarked for college can now be used for a trip to Mexico, a new car, etc.
Grandparents have used trusts for years to transfer assets to grandchildren (up to $10,000 a year without gift tax) while maintaining the ability to control the funds after the child reaches the age of majority. A trustee distributes the funds according to the trust's goals.
But trusts are expensive to set up and maintain well. They are also taxed highly and don't benefit from the tax advantages of other college savings plans.
Just say "yes" to free money! The gratis online service Upromise contracts with thousands of companies (McDonalds, Toys "R" Us, AT&T) to rebate part of customer spending as college savings. Subscribers can also earn rebates on groceries, gas, cars and restaurant meals. The savings are held in a secure Upromise account and can be transferred to a 529.
Jill Miller of Bridgewater, N.J., mother of two, opened a Upromise account and she recommends the free savings plan to others. "I like the tax benefits of the 529 plans linked to Upromise, and I like receiving money back for gas, groceries and other things I buy," she says.
Saving money for college is never an easy task, but if you start early you'll greatly lessen the load when college time rolls around. Since the birth of her daughters, Lauren Elliott of Killeen, Texas, has saved a little money each week, even though it's difficult. She plans to buy CDs that will mature when her girls turn 18. "I feel it's important for my children to go to college without feeling as though there's not enough money to do it," she says. "If I save now, the money will be there and my daughters can follow their dreams."