If you have kids headed to college, the annual costs may give you serious sticker shock. Consider these projections from The College Board’s Annual Survey of Colleges. For the 2018–19 academic year, the average annual cost for tuition, fees, and room and board at a private four-year college was $48,510. For public institutions, the price tag was $21,370—assuming you’re an in-state resident.
If you’re just starting to think about an education fund because your kids are still quite young, it may be hard to predict exactly how high those costs may be when they enter college. For the past decade, college prices have outpaced inflation.
“To help prepare for these rising costs, start saving as early as possible to help reduce the amount you pay out of pocket later,” says Tracy Green, CFP®, Planning and Life Events Specialist at Wells Fargo Advisors. However, even if you’ve set aside what you think will be more than enough for an education, Green says you can leverage many strategies and financial tools to help lessen the financial burden of paying for college. And if you don’t think you’ll be eligible for need-based financial aid, you may want to explore financial options that:
- Help take full advantage of your savings/investments.
- Employ tax-efficient tactics so you can put more of your money to work for you.
Here’s a breakdown of the most common—and often effective—ways to efficiently finance a college education:
1. Apply for merit-based and institutional aid
Your family doesn’t necessarily have to prove financial need for your children to be eligible for a scholarship or other merit-based award or institutional aid. Research different types of scholarships or institutional aid available—many applications are available online, and some awards are valid at any college. To boost the chances of receiving a merit-based award from a specific school, consider applying to a few colleges where academic achievements in high school would be likely to place your child in the top quartile of applicants. Your child may qualify based on a combination of high school grades, ACT/SAT scores, or extracurricular activities such as leadership roles and volunteerism. Academics usually play a role, but many merit scholarships are granted based on special talents a candidate may exhibit in the arts or athletics, says Green.
2. Consider federal student loans
Though high-net-worth families likely won’t qualify for need-based federal financial aid, your child may be eligible for unsubsidized federal student loans. These loans typically carry low interest rates and feature long payback periods. Filing a copy of the Free Application for Federal Student Aid (FAFSA) provides the school with the information necessary for determining a package of financial aid (need-based and non-need-based) for your child. “Having your child take out a small loan to help pay for some of the expenses, even though it may not be necessary, can be an efficient way for him or her to take on some responsibility and start building financial skills,” says Green.
3. Create a 529 college savings plan
If you still have multiple years before your child enters college, consider a 529 College Savings Plan, a widely used investment option, says Green. The after-tax dollars you contribute to one of these plans (with your child as the beneficiary) have the potential to grow tax-free. And, as long as you use the withdrawals to pay for qualified higher education expenses for the beneficiary, the account’s earnings are also potentially tax-free. With the passage of tax reform in 2017, the definition of qualified education expenses was expanded to include up to $10,000 per year for K–12 tuition which for some may create another reason to save even more money in the 529 plan.
Most states offer their own 529 plan, but you aren’t limited to what your home state offers. Some states provide upfront state tax deductions for residents’ contributions, so it will be important to research your state’s plan. “Even though your state may offer a tax deduction, it may be worthwhile to compare your state with other state plans for performance, fees, and flexibility,” says Green.
You should consider the investment objectives, risks, charges, and expenses carefully before investing in a 529 plan. You can obtain the official statement, which contains this and other information, by calling your financial advisor. Read it carefully before you invest.
- 529 plans are subject to enrollment, maintenance, administrative, and management fees and expenses.
- Nonqualified withdrawals are subject to federal and state income tax and a 10% penalty unless an exception applies.
- College savings plans offered by each state differ significantly in features and benefits. The optimal plan for investors depends on their objectives and circumstances. In comparing plans, investors should consider each option, fees, and state tax implications.
One more important thing to consider: You could be subject to taxes and fees if you don’t use all of the 529 savings for college or your child doesn’t attend college at all. “529 Plans can provide many tax benefits and flexibility when saving for education; however, the rules are somewhat complex,” Green says. “Be sure to talk with your tax and financial advisors prior to making any distributions or changes to the account owner or beneficiary to understand your options and avoid potential tax or penalties.”
4. Explore other options
Depending on your unique circumstances, you may be able to find other effective savings paths. If you own a business, you could hire your child and contribute an amount equal to their annual earned income to a Roth IRA held in your child’s name. After-tax contributions to a Roth generally have the potential to grow tax-free and you could later withdraw them for college. Earnings also could remain in the account for your child’s eventual retirement. Keep in mind that IRS rules for Roth IRA withdrawals need to be followed to avoid taxes and penalties.
If your child receives financial gifts from grandparents or other family members that you’d like to earmark for college, you could also talk to a financial advisor about whether to create an annual gift trust, minor’s trust or Uniform Transfer to Minors Act (UTMA) account.
More tips to help boost your savings
Overall, reducing taxes on your investments to make more of your money available for college expenses is a vital part of college-payment planning. However, taxes should never be your only consideration.
“In some cases, you may find that you have more investment choices or may earn a higher after-tax return on your investments in a taxable account rather than a 529,” says Green. “Or you may need additional savings to pay for expenses such as transportation and personal expenses which are not considered qualified for a 529 plan distribution.” The bottom line is that there are many ways to finance your child’s college education. A financial advisor can help you sort through the options that best meet your needs.