Cornerstone Planning Primer: Paying for College
College acceptance season is rapidly approaching for the freshmen class of 2018, so now is a great time to remind parents of future freshmen that they may want to be considering one important question: “How should we pay for it?”
According to Vanguard, college tuition is rising an average of 6% a year. The average tuition costs for a public university for the 2014-2015 school year was $18,943 a year for tuition, fees, and room and board. In 15 years it’s estimated to increase to $54,070. So, you can never start saving too early.
College can feel overwhelming for both the students and their families. But, with the right amount of planning, paying for it doesn’t have to feel that way.
Cornerstone Advisors also offers a once a year finance workshop for teens. We believe that when young people understand how to manage money, they are equipped with a lifelong skill that is essential to making their dreams a reality — and bringing reality to their dreams. Keep an eye out for upcoming Cornerstone events here.
The most obvious answer may seem to put away money every month into a savings account. However, if your investments aren’t keeping you ahead of inflation, you’re actually losing purchasing power each year on the money that’s just sitting there. In other words, unless your savings account has a rate of return greater than the average rate of inflation (3.22%), there are better options out there for you.
529 Savings Plan
529 savings plans are a state sponsored, tax sheltered, account where money can be deposited and grow tax free as long as the distributions are used for “education expenses,” which loosely means tuition, books, room and board, school supplies, etc. while the beneficiary is in school (any type of college or a trade school). Additionally, you can use any state’s 529 savings plan regardless of where you live.
While contributions are not deductible from the donor’s federal income tax liability, a prime benefit of the 529 plan is that the principal grows tax-deferred and distributions for the beneficiary’s college costs are exempt from tax.
A distribution from a 529 plan that is not used for educational expenses is subject to income tax and an additional 10% early-distribution penalty on the gains portion only. So, there is some risk if your beneficiary decides not to pursue higher education, but the designated beneficiary can be changed.
The annual contribution limit for the 529 plan is $14,000 ($28,000 for married couples) with no income limits. The $14,000 is the annual gift-tax exclusion amount and incurs no tax, has no filing requirement and does not eat into the lifetime estate basic exclusion amount. Lifetime contribution limits for 529 plans can vary by state but are high, ranging from $235,000 to $400,000.
The account value of a 529 plan, whether owned by the student or the parent, is considered a parental asset on the Free Application for Federal Student Aid (FAFSA), and 5.64% of a parent’s assets count toward his or her expected family contribution for paying for college expenses.
Unlike 529s, Roth IRAs permit funds not spent on education to be used for personal retirement, which provides a lot more flexibility than a 529 plan. Withdrawals are treated as a “return of contribution” first and as earnings second. This means that a person who has been contributing $5,000 per year for the past five years can withdraw $25,000 tax-free, provided the proceeds are used for qualified educational expenses. (Any withdrawals that exceed the total of one’s contributions and are attributable to earnings will be taxable for those under age 59½.)
Roth IRA accounts, like all retirement accounts, are not counted as assets on the FAFSA, which means the value of your Roth IRA won’t hurt your child’s financial aid eligibility. However, when you take earnings (not contributions) out from your Roth to pay for college, it will be counted as student income on the following year’s FAFSA. This can reduce a student’s aid eligibility significantly, since 50% of a student’s income is considered an available resource to pay for college when calculating financial aid.
Student Loans are a great way to fund your child’s education if you end up falling financially short on your college savings. If a student qualifies, federal student loans are the best option. They come with fixed interest rates and more lenient repayment terms, including a graduated repayment plan that allows the borrower to pay less in the early years when they first start to work and extended repayment plans that let them make payments for up to 25 years. Federal Student Loans are based on the FAFSA, which evaluates both family and student income levels. After reviewing the FAFSA, the school will let you know which types of loans you qualify for and whether they will be subsidized or unsubsidized.
If a student can’t get enough money through federal student loan programs, their most likely other option will be to apply for a private student loan. Generally these loans are at a higher interest rate and the rate is variable rather than fixed. These loans also are not included in the federal repayment programs if the borrower has trouble paying them back after they graduate. Most students apply for private loans with a parent or other co-signer who has a good credit rating. This allows them to qualify for lower interest rates.