Ways to Save for College

Ways to Save for College

August 02, 2021
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The reality of graduating with $80k or more in student loan debt hits hard for many students entering college. Taking on more debt to pay for a college education is hurting families and students all over the United States. With rising costs and no plans for loan forgiveness, the student loan crisis isn’t likely to go away anytime soon.

Saving for college can help reduce the financial burden of a college education on a family and help cover some, if not all of your student’s college expenses, reducing the amount of debt you or your student have to take on. It’s simple, the more you save, the less you have to borrow. There are many ways to save for future educations costs, here are some ways you can save.

 

Traditional Savings Account

A traditional savings account is something everyone should have, a storage place for short term savings. A savings account is also one of the safest places to store funds you are planning to use in the near future, as they are insured by the FDIC. They also offer the most flexibility in terms of who can open an account, who can contribute to the account and what the funds can be used for.

One of the major drawbacks to a traditional savings account is the low interest rates, so the funds within the account will not grow as much as other education savings vehicles. This may leave your student underprepared for education expenses and may best be used as a complement to your overall education plan.

 

Permanent Life Insurance

A permanent or whole life insurance policy can be used for more than just a death benefit, they can be used for education expenses as well by taking a loan out against the policy. For every dollar paid into a whole life insurance policy, a portion of the premium is diverted to a cash value account within the policy. By taking a loan out against the policy, the death benefit will be reduced by the loan amount if not paid back, which may be ok if you intend on using the policy to pay for education expenses.

 A whole life insurance policy also offers flexibility if your child receives a scholarship or decides not to go to college, you can leave the policy to grow or you can use the funds for something else. It may also take some time for the cash value account to surpass the premiums paid into the account so it may be difficult to pay for all of your student’s education expenses and may best be used as a complement to your overall education plan.

 

Roth IRA for teenage student

A Roth IRA is a great way for your teen to start saving for their future. A parent or other adult will need to open and manage the custodial Roth IRA for the minor child. There are no age restrictions in opening a custodial Roth IRA, as long as the minor has earned income. Contributions however are limited to $6,000 in 2021, or the total earned income for the year, whichever is less. Meaning if your teen makes $3,000 as a lifeguard, the maximum that can be contributed to the Roth IRA would be $3,000. If your team makes more than $6,000, the maximum that can be contributed is $6,000.

Although a Roth IRA is categorized as a retirement account, they can also be used for qualified education expenses. Contributions to a Roth IRA are made with after-tax dollars (also known as cost basis), earnings accumulate on a tax deferred basis and qualified distributions are entirely tax-free. You can always withdraw any amount up to your cost basis, tax and penalty free before 59 ½, however the earning portion of a Roth IRA is subject to ordinary income tax and a 10% penalty unless it is used for qualified education expenses. Qualified education expenses include tuition and fees, the cost of books and supplies, and room and board as long as the student is enrolled more than 1/2 time for Roth IRA distributions.

It’s important to note that the distribution must be used to cover qualified education expenses listed above and the Roth IRA must be open and funded for at least 5 years, which may limit the amount of time a teen can save for their education.


Eligible savings bonds

Series EE savings bonds issued after 1989 or Series I savings bonds offer a tax-advantaged way to save for future education expenses. Bond purchasers must be at least 24 years of age and can be purchased for minor children, but the bonds must be registered in the parent’s name. Bond dollar amounts are set by the IRS and can be purchased online or through your federal tax return. Savings bonds are backed by the full faith and credit of the United States, giving bond holders little fear of losing their principal investment, making them a safer investment vehicle that may have modest returns.

The interest earned on Series EE and Series I savings bonds is generally tax free if redeemed for qualified education expenses. Bond redemptions must be used in the same tax year as they are redeemed and if the redemption amount exceeds the amount used for qualified educational expenses, the interest earned will be taxed on a prorated basis. Qualified education expenses do not include room and board for savings bond redemptions.


Custodial Account (UGMA or UTMA Account)

Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minor Act accounts (UTMA) allow a custodian to open an investment account on behalf of a minor beneficiary to save for future education expenses. All assets within an UGMA or UTMA account transfer to the minor when they reach the age of majority. There are no income or contribution limits for custodial accounts and they can be used for any education expense k-12 or postsecondary.

When the beneficiary reaches the age of majority, they become the owner of the account and can use the account as they see fit, withdrawals are not limited to qualified education expenses. There are also no tax benefits when contributions are made and earnings within the account are taxable.


Coverdell Education Savings Account

Coverdell Education Savings Accounts allow you to open an investment account to save for the future education costs of a minor. The funds invested in a Coverdell account have income limits (Modified Gross Income (MAGI) of $110,000 for a single filer and $220,000 for married couples who file a joint return in 2021), as well as a contribution limit of $2,000 per year, per beneficiary. With such a small contribution limit, a Coverdell Education Savings Account may best be used as a complement to your overall education plan.

Contributions made to a Coverdell are not tax deductible but the earnings grow tax-deferred. Withdrawals for qualified education expenses are generally tax-free and can be used for k-12, as well as post-secondary education expenses. If the beneficiary does not use the account for qualified education expenses, the account must be distributed by the time the beneficiary reaches 30 or the owner has the ability to change the beneficiary to a “family member”, as defined by the IRS. If funds are withdrawn for non-qualified expenses, any untaxed earnings are taxable to the beneficiary, along with a 10% penalty.


529 Plans

529 plans or “qualified tuition plans” are typically the most well-known education savings vehicle and are designed to encourage you to save for future education costs, while taking advantage of tax benefits. Contributions are limited to $15,000 per year, per beneficiary ($30,000 from married couples) in 2021. 529 plans are sponsored by individual states or educational institutions and are broken down into two categories, Education Savings Plan & Prepaid Tuition Plans. It’s important to note that not all states offer tax benefits so be sure to consult a financial or tax professional for your specific situation.

Education Savings Plan

Education savings plans allow the account owner to open an investment account to save for the beneficiary’s future qualified education expenses. These plans can generally be used at any college or university, as well as vocational/trade school and up to $10,000 a year for k-12 tuition expenses. Education Savings Plans allow the beneficiary to withdraw money from the account for qualified expenses without paying taxes or penalties. If funds are withdrawn for non-qualified expenses, any untaxed earnings are taxable, along with a 10% penalty. Qualified expenses are as follows:

               Tuition & related fees

               Room & board

               Off-campus housing

               Meal plans & food

               Books & supplies

               Computers, related equipment & software

               Internet services

               Repayment of student loans

Prepaid Tuition Plans

Prepaid tuition plans allow the account owner to prepay for tuition and fees at current prices, which could be a lot cheaper considering the skyrocketing costs of education. These plans are available only at participating institutions, are typically state sponsored and have residency requirements. Prepaid tuition plans do not cover room and board and do not allow you to use funds for k-12 education. 

The account owner choses the beneficiary and has the ability to change the beneficiary to a “family member”, as defined by the IRS. This is helpful when you are planning for multiple students or if the beneficiary choses not to go to college or receives a scholarship. If the beneficiary chooses to attend a non-participating institution, the plan will pay but may pay less than at a participating institution.


Bottom line, start saving what you can, as early as you can and work with a professional for the best way to plan for your family. Saving for education expenses could also have a significant impact on your student’s financial aid so it’s always a good idea to work with a financial or tax professional on your specific needs.

 

 

DISCLOSURE:

Stephanie Follin is a Registered Representative with and securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.