What You Need to Know about College Savings Plans
In an increasingly competitive job market, a college degree can enable applicants to stand out and help to expand access to high-paying positions. One of the key findings in the America's Divided Recovery report, compiled by the Center on Education and the Workforce at Georgetown University, was that college graduates are eligible for 57 percent more jobs than individuals without a degree. College graduates also have the potential for greater earning potential, increased marketability, and more networking opportunities than those without a degree. Therefore, it is critical to start saving for your child's college education as soon as possible.
Cost of Education
Before you begin to save for your son or daughter’s education, it's important to have an idea of how much you will need. Factoring in fees and living costs, the average cost for one year of study at a top-tier university is approximately $60,000. A four-year program, then, could cost as much as $240,000. You can find much more affordable options if you consider public universities. For instance, the cost of tuition for state residents at state colleges was an average of $10,230 in 2018-19, according to the College Board.
Cuts to funding in higher education have led to a significant increase in tuition costs over the course of the last decade with a more drastic rise in some states. For instance, the average cost of tuition in Arizona and Louisiana has more than doubled since 2009. When calculating how much you should save, consider that costs are expected to continue to increase.
While there are few clear guidelines about how to properly plan and save for your child’s college education, one strategy is to follow the “2K rule,” which assumes that a $36,000 fund is appropriate to cover half of your child's education costs. Under the 2K rule, you would multiply your child's age by $2,000 to determine how much you should save at various points in their life. For instance, if your child is 10 years old, then you should have $20,000 in savings. Keep in mind that the rule assumes the use of a 529 plan.
529 Savings Plans
There are two distinct types of 529 plans: 529 savings accounts and 529 prepaid tuition plans. The former allows you to invest in exchange-traded or mutual funds and isn't subject to taxation at the point of withdrawal, so long as the funds are used to cover qualified educational expenses, including tuition, books, and room and board. Non-qualified expenditures, such as the purchase of a vehicle or general living expenses, are not only taxed but are subject to a 10 percent penalty.
The plans vary and can have different credits or tax breaks available depending on the state in which they are offered. They work like Roth IRA accounts, but have higher contribution limits. Many of these plans also do not have age restrictions or limits on household income. Another benefit of a 529 savings plan is that it is counted as a parental asset, meaning that it will have minimal impact on your child's ability to earn scholarships and other types of financial aid.
If you are considering this plan, it is important to keep in mind that there is risk involved in playing the stock market. If there is a down market at the time that you tap the funds, it could have an impact on returns.
529 Prepaid Tuition Plans
One way to address rising tuition costs is to save through a 529 prepaid tuition plan with a specific college or group of institutions. Although these plans are increasingly being phased out or subject to new restrictions, they are still being offered in 11 states, including Florida, Illinois, Nevada, and Massachusetts. The plans allow contributors to “lock in” their tuition costs at the current rate. For instance, you can begin paying for your child's 2038 tuition fees at the 2020 rate.
Roth IRAs, or Individual Retirement Accounts, do not necessarily have to be used solely for retirement purposes. Contributions grow tax-free, and withdrawals for educational purposes aren't subject to penalties. They also offer more flexible investment options than a 529 plan and are particularly useful if you're unsure as to whether or not your child will attend a post-secondary institution. However, Roth IRAs carry income restrictions and have lower contribution limits than 529 plans.
Other savings options that offer tax benefits include trust accounts and Coverdell Education Savings Accounts (ESA), the latter of which are similar to 529 plans but have many more restrictions. Contribution limits for ESAs are only $2,000 per year. They are better suited for individuals who plan to enroll their children in a private school, as qualified expenses include tuition for K-12 through graduate school. Beyond these options are Uniform Transfers to Minors Act custodial accounts, savings bonds, and gifting.