Being able to afford a college education for your children or grandchildren is one of the top goals for most parents and grandparents.  This goal is becoming more difficult for most families.  According to the Department of Agriculture report, the average cost to raise a newborn child in the United States is $284,570, and this does not include college.  Depending on where you live in the United States, this number could be higher.  So how do you save for college and where should you begin?

Where to Begin

As a parent, you need to look at a few things before you start saving for college.  This list may change in priority for each family, but all of them need to be considered before you create your plan.

• Time before the first child goes to college
• Age of the parents when the last child graduates from college
• Identify the amount that can be saved per month
• Save for retirement at the same time
• Set up an account for educational funding gifts
• Created an estimated goal by child
• Will any of the children be in college at the same time

This process can be daunting but the sooner a family starts analyzing their unique financial situation, the sooner you can develop a strategy on how to pay for college.  I am seeing this lack of planning illustrated through the growing higher college debt levels. Today, student debt is over 1.52 trillion dollars and growing.   To help your children reach a level of independence without excessive student debt, you need to make saving and college planning a priority as a parent.

Determine Your Financial Aid Position

A key term in the college funding and financial aid process is called your Student Aid Index or (SAI) This number is used to determine if a family will qualify for need-based financial aid. We would recommend that you determine that number since it may make your saving goal a little more realistic rather than the list price of many of these colleges.

By understanding your SAI, you will be able to create a better saving plan and other paying strategies to lower your total net cost of educating your children.  A good exercise in the college saving planning process is to build your estimated SAI and align it with some of the colleges that your child may want to attend.  With this information, you can better understand your financial aid position at the different colleges and the possible financial aid you will qualify for as a family. 

Family Timeline is Important

Before you rush out and try to find the right investment option, the priority for me is establishing a family timeline.  This will identify a few things for you:

• Recovery time for retirement saving after all the children graduate
• Beneficial financial aid position due to multiple children in college (Lower EFC)
• Amount of time when tuition is payable
• Help prioritize retirement and college saving goals

By understanding the timing, you can then determine which investment options will be the most beneficial.  You may need to have a combination of retirement tools and college saving tools to attain both your goal of saving for retirement and college funding.  Each savings investment accounts have different features and benefits.  Before making any investment decision, you need to understand the access to the funds, penalties, and cost of each investment.

College Saving Investment Options

Students Saving Account (UGMA or UTMA)

This is an account that is in the student’s name with a person assigned as a custodian of the account.  The account funds must be spent for the benefit of the child.  It is under this legal structure to protect the child.  Depending on the state, the account becomes the child’s money at age 18 or 21.  This can be a bank savings account, checking account, or investment account.

The myth of assets in your child’s name affecting the financial aid process is not always true.  A family needs to understand their SAI and the colleges they are considering before that decision can be made.  By moving assets out of a child’s name, there could be significant tax and legal consequences if not done correctly.

US Saving Bonds

This is an investment that has the full backing of the US Federal Government and grows with interest that is earned based on the type and month purchased.  This investment is often given as a gift to younger children with the expectation of tax-free growth for education.

This investment offers the most amount of financial security.  To receive the tax-free benefit, it must be titled correctly and used for qualified educational expenses.  At the time a parent redeems the bonds, there are income limits based on the tax filing status of the parent that needs to be considered.

529 Plans

A 529 Plan is an investment plan operated by a state designed to help families save for future college costs.  There are a few non-state 529 plans.  As long as the plan satisfies the federal tax law requirements, it will provide special tax benefits to the plan participant and beneficiary of the plan. (Section 529 of the Internal Revenue Code).

It is up to each state to decide whether it will offer a 529 plan (or possibly more than one), and what it will look like. The 529 plans are usually categorized as either prepaid or savings, although some have elements of both.

With the 2018 tax code change, 529 plan money can now be used for elementary and secondary schooling.  It does have an annual limit of $10,000 per year per child.

Coverdell Saving Plan

This plan is also called an Educational IRA.   This investment option can be used for college and tuition expenses of elementary and secondary school.  There are contributor income limits and investment amount limits per child per year from all sources.   The annual limit is $2,000 per year, and the source of funding is limited by income level based on the tax filing of the person.

The significant advantage to a Coverdell Plan is the investment flexibility that the 529 plan does not offer.

Parent Investment Portfolio

This is a general investment tool.  The investment goes into the account with after-tax money and offers the most amount of investment flexibility.   The limit to these accounts is the tax consequence of liquidating the account for the payment.  If held long enough, it will qualify for capital gains tax treatment.

For financial aid positioning, this could also be an advantage since parent taxable investment accounts are weighted in the SAI calculation at 5.64% rather than the student’s rate at 20%.  The parent also receives an asset allowance based on their tax filing and age.

As stated above, a family must understand their EFC positioning before starting their saving plans.

Roth IRA

This is primarily a retirement-saving investment option.  The investment goes into the account with after-tax money.  After five years, these contributions are available for educational expenses if correctly withdrawn.  There are specific contribution rules set by the IRS, which may limit your ability to use this option.  The Roth IRA option allows parents to save for both retirement and college.  It is not counted in the Federal EFC calculation but is reported under the CSS method.  It has better investment flexibility and grows tax-free.  It is an excellent option to consider when you have younger children.   Money must be in the plan for 5 years before you can have access to withdraw without any penalty.

Trust Beneficiary

This is a general investment tool normally set up by another family member.  The investment goes into the account with after-tax money and offers investment flexibility.  This option allows the trustee to control the distribution of assets over a specific period. This investment is counted in the Federal SAI calculation and CSS profile method by each beneficiary.  The listed beneficiary name is where the asset value will be reported.  These plans are often set up as a simple solution for estate planning but ignore the financial aid position of the individual family members.  This is especially a problem when a family may qualify for need-based financial aid.

College Saving Summary

Finding the best ways to save and pay for college is becoming a more significant part of many families’ financial plans.  Educational savings plans are just one way families can begin this process.   Having a combination of strategies will better help families reach the goal of educating their children at the lowest cost.

If you find that you need help creating the proper strategies for saving and paying for college, we recommend that you see an advisor with the CFSLA designation.  These advisors take a holistic approach to the situation and are trained in this area.  Advisers need to understand the financial aid process, college savings plans, educational tax strategies, student loans, and various loan repayment options.  PayForED website does have a list of College Funding & Student Loan Advisors (CFSLA) listed on our website who can provide additional help if needed.