Elizabeth Barrett, MA, CFP®
Talk to a parent about paying for college, and chances are you’ll soon be discussing student loans. But your options go far beyond borrowing at the time your child enters school. Numerous possibilities are available to save in advance of college and to win scholarships. What’s your best college savings option? Most ACA advisors follow the rule to save in the most efficient place now and spend from the most efficient place later. Because tax laws and our lives are always changing, it’s dangerous to conclude that any one option is the best place to save for something that’s 10 or 20 years down the road.
Often the best place to save for a child’s college education is the parent’s Roth IRA, if the parent is eligible. There are several advantages:
• The savings grow tax deferred, and the contributions can be taken out without penalty.
• The money stays in the parent’s name, where it remains in the parent’s control and typically has a smaller impact on college financial aid awards.
• Money in the Roth IRA can be used for various family members’ college expenses.
• When money is withdrawn for college expenses, the Roth’s earnings may be taxable but are penalty free.
• And of course, the funds may be needed for retirement instead of college. (Like many ACA planners, I remind clients that children can always borrow to go to college, but their parents can’t borrow for retirement.)
If Roths aren’t an option for parents, either because they have already maxed out their contributions or aren’t eligible, the next choice may be a Roth in the child’s name. If children have earned income, they can make a Roth contribution, which can later be used for their college education. And if the Roth isn’t used for college, teenagers have either college money for their own little ones in the future or for the down payment for a house. (Or maybe you’ll enjoy a fun golf partner because with such an early start, your child may retire by age 40!)
Another option is a Section 529 plan or Qualified Tuition Program. The donor (usually a parent or grandparent) makes a contribution into a Section 529 plan and investments are purchased within the plan, much like a 401(k). Investment options vary by state. Withdrawals are not taxable when less than or equal to annual qualified higher education expenses, adjusted for tax-free education assistance and amounts used to figure education credits. A 10% penalty is imposed if the funds are not used for college education, but only the earnings are penalized. If a grandparent or parent has an estate tax problem, they can reduce their liability with a contribution to the beneficiary’s 529 plan. This is considered a “completed gift,” so it’s no longer in the grandparent’s or parent’s taxable estate. Section
529 plans differ from other college savings options in many significant respects:
• Unlike Roth IRAs or other options, Section 529 plans aren’t subject to income limits: you can contribute no matter how much you earn. • Unlike certain prepaid plans, you can invest in another state’s plan, and the student can go to school in any state.
• Unlike UTMA (Uniform Transfers to Minors Act) accounts (custodial accounts), the donor maintains control and ownership, so if your oldest child doesn’t attend college, you can use the account to pay for another child’s (or other relative’s) college expenses. The proceeds of a Section 529 plan can be used not only for tuition but also for books and room and board. (If the child lives at home, he can pay a room and board allowance specified by the school to Mom and Dad.) And if your scholar receives a full tax-free scholarship, the money can be taken out without incurring the 10% penalty. Not all Section 529 plans are created equal.
Ask your ACA advisor for help identifying the best plan for you and your beneficiary. A related college savings option is the Upromise Credit Card (www.upromise.com). When you make purchases at any of more than 8,000 restaurants or 600 online retailers or you buy eligible items at the grocery or drugstore, a cashback percentage is directed into your Upromise account, which you can then use to fund a Section 529 plan or to pay college expenses or a student loan. Of course, just about the only thing better than saving in advance for college is going to college for free. Websites such as http://www.Fastweb.com and http://www.Collegeboard.com/ScholarshipSearch can help you search for a fit between the student and any of thousands of available scholarships totaling over $1 billion. (One caveat: such sites can be rife with ads and special offers, so be careful when filling in information and checking boxes.) Other sources of college aid information include http://www.WiredScholar.com, http://www.FinAid.com, http://www.eStudentLoan.com, and http://www.Scholarships.com.
Trying to decide among all your college financing options can be confusing. A call to your ACA advisor can help you determine which options are best for you and offer you the greatest chance of realizing not only your family’s college dreams but your other goals as well.
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