Financial Planning: Saving for College
March 09, 2011It’s that time of year again. No, I’m not talking about taxes, spring cleaning, or even baseball (although it is that time of year as well). I’m talking about March Madness, and as I watch those amazing kids compete for college basketball’s ultimate prize, I’m reminded of just how unlikely it is my own kids will be getting a basketball scholarship anytime soon.
With the prospect of four children heading off to college someday, you can imagine the ulcers I develop when I start to think about college planning. According to The College Board, the average published cost for a four-year public school is around $7,600 a year, and that’s just tuition and fees. When you throw in room and board, that number climbs to over $16,000. Throw in a 5.5% inflation rate and you’re looking at over $32,000 by the time my five-year old Jacob heads off to school (although if preschool is any indication I might not have to worry about him). So how does the average person afford college these days? I see at least three pieces to the college planning puzzle: Savings, Financial Aid, and Income. I’ll cover the first piece this week, and the other two in the weeks to follow.
Saving for college
If your children have not entered college yet, then there is still time to save. It is unlikely that the average parent will be able to save enough to fully fund their child’s education, so I suggest setting a goal of trying to save enough to cover at least 50 percent of the projected cost. If you can save more, great! If not, that’s okay; every bit will help. There are two primary savings vehicles that offer tax-free benefits if the funds are used for qualified education expenses: the Coverdell Education Savings Account and the Section 529 Plan.
The Coverdell Education Savings Account
The Coverdell Education Savings Account (CESA) is simple to open and is available through most financial institutions. Funds may be withdrawn tax free to pay for qualifying expenses associated with post-secondary education (i.e. after high school), and for the next two years (2011 and 2012) distributions from a CESA may also be used to pay for expenses associated with kindergarten through 12th grade.
The CESA has an annual contribution limit of $2,000 (subject to income limitations), so it may not cover as much of the cost as you would like. Also, there are no tax deductions available for contributing to the account.
Section 529 Plan
There are two types of 529 plans: prepaid and savings. Every state offers a 529 savings plan, but only a handful offer a prepaid plan. The prepaid 529 plan allows parents to purchase tuition credits in today’s dollars, so if you have a chunk of change lying around and you want to go ahead and pay for college today, this may be an option you wish to look into further. Just remember, your child may be required to attend a college in the sponsoring state in order to receive the full benefits of the prepaid program.
Because of this potential limitation, and because not many parents have a chunk of change lying around, the 529 savings plan is much more popular. This plan allows parents to save money tax deferred, and may be withdrawn tax free to pay for qualifying post-secondary education expenses. Unlike the CESA, contribution limits to a 529 savings plan are much higher, in some cases in excess of $300,000 over a lifetime. Also, some plans offer state income tax deductions for contributions made by the residents of the sponsoring state.
People often ask, “Which 529 plan is best?” There is no one “best” plan, and you have to consider a number of factors, including program fees, investment options, and state tax deduction eligibility. To learn more about the 529 plans offered by each state, talk to your financial advisor, or visit www.savingforcollege.com.
Next week’s blog topic: Financial Aid