With the ever-rising cost of college tuition in the United States, many parents begin worrying about how to pay for their child’s education immediately after birth – and sometimes, well before that!
Opening a savings account in your child’s name might seem like a good idea, but a large amount of cash in the student’s name can affect grants and scholarships down the line. On the other hand, only a portion of the parents’ income and assets are used to calculate financial aid, so it’s not always a good idea to have your child’s savings account as the sole method for stockpiling cash for college.
Luckily, there are a few ways to save for college that won’t affect your child’s chances of getting financial aid.
529 College Saving Plans
A good way to save is through a 529 college saving plan. These plans operate similarly to IRA and 401(k) accounts, allowing parents to save for education tax-free. It’s investment-based, so you can change your approach to be more or less aggressive as the stock market evolves through the years. The tax-related benefits are great, and the fund can be used for undergraduate or graduate studies at any 2-year or 4-year accredited campus in the US. Plus, the savings belong to the parents, not the child – so there’s less of a risk of little Johnny throwing all your hard work down the drain. The fund’s beneficiary can also be changed, so if the child doesn’t want to go to college, the money can be used for someone else’s education. Though there a few restrictions regarding what the money can be used for and when tax penalties could apply, overall it’s a good option.
Prepaid Tuition Plans
A prepaid tuition plan works much the same as a 529; however, it’s not subject to the stock market. Parents purchase tuition credits in advance at a predetermined price – the catch, though, is that the plans are usually restricted to in-state schools if you want to reap the full benefits. If your child decides to go to school out of state, you’ll be able to use the money, but you won’t get the full return on your investment. For example, if a parent purchases one year of tuition at a Michigan school for $14,000, it wouldn’t matter if Michigan tuition rose to $25,000 – that student would still get a full year of college for $14,000. If the student decides to go to a California school, you’d be able to use the $14,000, but you’d have to make up the difference if tuition was $25,000.
It’s important to note that you can use both types of accounts for college savings – maybe a prepaid plan for tuition, and a 529 for room and board and school supplies.
Once a student begins earning his or her own income, parents can set up a Roth IRA in the child’s name. This is a good option if you have cash saved up, but want to protect the funds – restrictions on Roth IRA accounts prevent penalty-free withdrawals until the age of 59 ½. However, there are exceptions to the rule that allow early withdrawal for qualifying educational expenses – meaning your child can withdraw for tuition payments, but not for a spring break trip to Cabo.
If you’d like to speak about your options concerning college savings, call our Wealth Management guru, Scott Brady, at 248.443.4234.