Know which paths to take to combat rising college costs.
Harvey Mudd College heads the total cost list at $69,717, while Columbia University charges the most for tuition alone: $55,161.1 Few students pay these totals. Scholarships and financial aid can cover some expenses, and state universities and colleges cost much less. Nevertheless, 61% of undergraduates leave school with debt – an average of $28,1002.
You might expect parents and grandparents would be saving large amounts in tax-advantaged college savings programs. However, Sallie Mae, the nation’s largest college student loan company, found that although 57% of parents are saving to fund a college education, only 37% do so in a tax-advantaged way.3
If you intend to pave someone’s path to higher learning, you have several choices.
Section 529 College Savings Plan
Generous contribution limits and potential for tax-free qualified withdrawals make a 529 plan the choice for many families. A grandparent can lump together up to five years of gift tax exclusions for a $70,000 one-time contribution ($140,000 for a joint contribution). States also offer tax breaks on plan contributions. Check out prepaid tuition plans in your state, too – but only if you’re comfortable with the child being limited to participating colleges.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer’s official statement and should be read carefully before investing.
Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan. Plans offered outside your resident state may not provide the same tax benefits as those offered within your state.
Coverdell Education Savings Account
This tax-advantaged account’s only drawback is its modest contribution limit – $2,000 per year. If your modified adjusted gross income is less than $110,000, you can use contributions to cover qualified higher education expenses or elementary and secondary education expenses, a key difference from other education accounts. Contributions grow tax-free and qualified withdrawals are free of tax at the federal level and often at the state level. Any funds left in the Coverdell ESA must be distributed to the beneficiary when he or she reaches age 30, unless that person has special needs.
You also can make a contribution under the Uniform Gift to Minors Act or Uniform Transfer to Minors Act, but many avoid this path because it has a possible drawback – the “gift to the minor” is irrevocable. The contributor loses control of the assets, which become the property of the child once he or she reaches the age of majority (usually 18 or 21), an age not necessarily associated with astute financial decision-making. Also, the child’s assets will work against financial aid calculations.
Outside the Box
Other savings avenues are possible. If you qualify, you could open a Roth IRA (2017 limit: $5,500; $6,500 if you’re 50 or older) with the idea of using some of your contributions (not your gains). You can extract your after-tax contributions at any time, for any purpose, while leaving your gains to grow tax-free to support your retirement. Or consider tax-efficient investments; your withdrawals won’t be tax-free, but they can be used for any purpose without any penalties to consider.
1 Chronicle of Higher Education, 2016
2 The College Board, 2016
3 “How America Saves for College 2016,” SLM Corporation