Investing in the Future: Tips on How to Finance a College Education in Today’s World
Education enables people to develop the skills, knowledge, and experience needed for a more secure future. Yet the cost of higher education can prove problematic, even prohibitive for many individuals with tremendous potential.
Fortunately, there are several resources available to help parents and students save for, and ultimately, finance a college education. There are numerous options within each strategy, from savings plans to scholarships and grants to student loans. But navigating this vast array of options can be a daunting task, especially the first time around.
Here are a few ways to help you plan for college education expenses:
It’s never too early to start saving. There are a variety of savings accounts specifically designed to offer tax-advantaged ways to put money away for schooling, from kindergarten to post-graduate degree programs. In general, “tax advantaged” refers to the fact that when funds are withdrawn for “qualified education expenses” (which vary based on the type of plan) the growth and earnings in these accounts are generally exempt from federal and state income tax. There are additional tax advantages associated with some types of accounts which can be valuable to the student, as well as a benefactor who may want to help the next future rocket scientist in the family get off the ground.
Coverdell Plans: Coverdell Plans are tax-advantaged savings plans structured to save for K-12 as well as higher education expenses. Annual Coverdell contribution limits ($2,000/year currently) are much lower than traditional college savings plans, and one’s ability to contribute is subject to MAGI (modified adjusted gross income) limitations. No contributions are permitted after the beneficiary reaches the age of 18, and the funds must be used by age 30 to avoid adverse tax consequences (unless the beneficiary has special needs). However, the beneficiary of a Coverdell Plan may be changed to a qualified family member, allowing younger siblings to use and benefit from the accumulation and growth of funds over time.
529 Plans: 529 Plans, on the other hand, are tax-advantaged savings accounts primarily designed to finance higher education. As such, 529 Plan contribution limits are lifetime based; are considerably higher (usually $350,000 and up); and participation is not limited by household income levels. These are just a few characteristics which make 529 Plans particularly attractive, not only as tax efficient education savings vehicles, but also as a tool for utilizing annual and lifetime gifting exclusions for both parents and grandparents. In fact, there are special rules which provide for accelerated annual gifting into 529 Plans.
There are two types of 529 Plans available: Savings and Prepaid-Tuition. Here are some important things to keep in mind when considering if one of these are the best option for your family.
Savings Plans are generally administered at the state level and offer more flexibility both in terms of school selection and what is deemed to be “qualified expenses” for tax free withdrawal purposes.
Prepaid Tuition Plans may be state-sponsored or school-sponsored. These plans usually only cover undergraduate tuition and fees and may limit the usage of your prepaid credits to in-state schools or private colleges and universities participating in a particular plan.
The key to choosing the right plan is first understanding the interests and goals of the student and your family. Then explore the various plans available in your state, and in some cases, where the student may wish to enroll. And finally, find a plan that both covers the expenses you anticipate and also offers some degree of flexibility should the needs or interests of the primary beneficiary change.
U.S. Savings bonds: Series EE and Series I Bonds are another form of a tax-advantaged investment. If the bond proceeds are used for qualified education expenses, interest is generally exempt from state and local taxes. Under certain circumstances, interest may also be exempt from federal taxes. But several restrictions apply. Education bonds are a great way for parents to establish a nest egg early for their potential future collegians. While the yield is relatively low and the amount which may be purchased in a given year is limited, U.S. savings bonds are backed by the full faith and credit of the United States government. The low-risk profile of these bonds is often attractive to young families. Also, subject to certain rules and limitations, the proceeds from these bonds may be afforded qualified education expense tax treatment if they are later deposited into a 529 or Coverdell plan down the road.
In addition to savings plans, there are many other sources of funds available to support financing a college education. These sources fall into two basic categories, federal and private. Both provide aid in the form of grants, work-study programs, and loans.
The Free Application for Federal Student Aid (FAFSA) which determines eligibility for federal financial aid, is the first step in the financial aid process. This includes grants, work-study programs, and loans. FAFSA is used to calculate the expected family contribution (EFC), which is the amount of money a student and their family is expected to contribute towards the cost of education. The EFC is then used to determine the student's eligibility for financial aid.
Private entities including financial and educational institutions, and foundations with special interests and purposes also use the information provided on FAFSA. However, their criteria for determining a student’s need or eligibility for aid is often quite different. Their decisions will largely be driven by their own financial situation and ability to provide funding.
When applying for financial aid, it is important to realize that not all assets and income are created equal. In fact, what may be beneficial in one regard may prove counterproductive when it comes to enhancing eligibility for other valuable forms of financial aid. Therefore, it is imperative to start the financial planning process as far in advance as possible in order to title, spend, save, and position assets in the most effective way possible.
Finally, a little detective work may go a long way. Believe it or not, millions of dollars in scholarship money goes unused each year simply because they go unnoticed. No one is awarded the funds because no one applies for them. There are many unique scholarship endowments created by private citizens to nurture a creative interest or the special need of a student like themselves. High school guidance counselors can be a great resource to help students track down scholarships that they may be qualified for and receive just for the asking.