Giving your child a good education can seem expensive, but with proper planning and an early start, they can be quite affordable. A lot depends on the college chosen and the amount of financial aid available to you. The key is to begin planning when your child is young, perhaps even before birth, and to understand the most efficient ways to pay for future college costs.
Major Costs Of Education
By the time you child carries away their degree, you will have spent a great deal of money on many different expenses. But while many side costs may be negligible, there are several major expenses which you should begin to prepare for well in advance:
- Tuition: This is the price that schools charge for classes. It is usually figured at a price per credit, with so many credits assigned to each course. You'll probably encounter mostly 3-year and 4-year credit courses, though special courses may have a greater or fewer number of credits. Full-time college or university attendance will require a minimum number of credits per term or semester, ranging from about 16 to 20 or more. Some schools have 2 semesters per academic year plus 1 or 2 summer school sessions. Others work off of a trimester schedule or some other variation. Online programs may have no set timetable.
- Fees and books: Schools charge administrative fees of various types, such as for registration. Books and other educational materials can cost hundreds or thousands of dollars per year, although many schools offer online materials at discount.
- Room and board: Unless your child plans to live at home or with a relative while attending school, there will be costs associated with rent and food while at school. Schools may offer on-campus and off-campus housing and a cafeteria plan for a set fee per semester. Of course, your child can choose to make other arrangements involving non-school housing and dining, but you'll still need to estimate and plan for these costs if you want to pay for them on your child's behalf.
- Other costs: You may encounter other costs, such as transportation, special tutoring, costs associated with athletic programs (equipment, uniforms, etc.) and more.
As you can see, there are several cost components to consider when planning your approach to paying for school. Here, we at GET.com will guide you through what you need to know about the costs of education and the alternative ways for paying them.
A Snapshot Of College Costs
The College Board publishes annual average costs for tuition, fees, room and board, categorized by the type and location of the school. Undergraduate programs in your state or district of residence are, on average, less expensive than are ones out of state. As you would expect, 4 year programs cost more than 2 year ones, and private schools charge more than do public schools.
The 2015-16 average annual costs for full-time tuition and fees, and room and board, are:
The costs vary considerably. A child attending 2-year community college while living at home will require on average $6,870 over the 2 years. Sending a child away to a private nonprofit college for 4 years will cost on average more than $131,000 in total. These are averages, expect to pay more for the top schools in the country, although these often have more generous financial aid packages.
The rest of this guide provides strategies to pay for and/or reduce these costs through the use of savings, aid and loan programs. In addition, many students earn money when attending school in various ways, including full- or part-time jobs, college work-study programs, private tutoring. But as this guide is for parents, we will not address this issue further.
You can fund your child's education from your own portfolio of investments and savings, but there are also tax-favored methods to cover education costs.
Section 529 Plans
Section 529 is the regulation providing for certain accounts that are tax-free when applied to qualified college costs. The 2 major types are:
1. Prepaid Tuition Plans: Usually state-sponsored, these accounts let you pay in advance, often at a discounted rate, for tuition credits at an eligible school within the state. The state controls the money you pay for credits and invests it as it sees fit. You neither suffer from poor investment returns or benefit form excellent ones, you simply are purchasing guaranteed credits. There is at least 1 national program, the Independent 529 Plan, that covers approximately 300 educational institutions in the U.S.
2. College Savings Plans: These are accounts in which you invest and control your contributions, which grow tax-deferred. Your money can be withdrawn tax-free to pay for qualified education expenses, including tuition, fees, room, board, supplies and books. The account balance you'll have when you send your child to colleges depends on the plan's performance. These plans are frequently available from mutual fund companies that manage the funds on your behalf.
Your 529 Plan contributions in excess of the annual gift-tax exemption ($14,000 in 2015) are subject to the annual gift tax, although they can be included in your lifetime gift tax exemption, $5.43 million per individual in 2015. A special provision lets you contribute a lump sum equal to 5 years ($70,000) of the annual exemption and then take the exemptions over the next 5 years without penalty.
You can avoid questions from the IRS about the use of 529 Plan withdrawals by transferring distributions electronically directly to the school. Many plan sponsors offer this feature, as well as a feature facilitating regular monthly contributions directly from your bank account.
Money set aside by a parent in a 529 plan is included in college aid formulas, at an assessment rate of 5 to 5.6 percent per year. Grandparents can use 539 Plans to good effect. Normally, distributions from a grandparent's plan will reduce the student's federal aid by 50 cents on the dollar, but this can be avoided by postponing distributions until the aid is finalized, usually by the sophomore year.
When choosing a College Savings Plan, be aware that most states with an income tax offer a credit or deduction for contributions to the plan. For example, Michigan provides up to a $10,000 state tax deduction for 529-Plan contributions. The value to you is your marginal state income tax rate times the contribution. If your Michigan tax rate is 4.25 percent, your maximum tax deduction would be worth $425.
Another deciding factor is the plan's expense ratio. Michigan charges a modest 0.2 percent if you invest the money in a stock index fund. Other plans might charge quite a bit more, so it pays to investigate how fees can mount up. For example, you'll pay more if you use a stockbroker and make frequent trades.
Coverdell Education Savings Accounts
These plans allow you to contribute up to $2,000 a year, which grows tax-deferred and is tax-free when distributed for eligible education costs. Contributions may be banned if your income exceeds certain limits. There are no state tax deductions for contributions to Coverdell accounts. You must start a Coverdell account before the student turns 18, can't add to it after that, and must spend the balance by the time the student reaches 30-years old. Coverdell accounts can also be used to cover private school costs for grades K through 12.
Normally, you'll pay a 10 percent early withdrawal fee when you distribute money from a retirement account, such as an IRA or 401(K), before age 59 ½. However, you can take early withdrawals without penalty from IRAs (although you'll have to pay income taxes unless it's a Roth IRA) if you use the money for qualified education expenses for yourself or other family members. The penalty exception does not extend to qualified retirement plans such as 401(K)s or 403(b)s, but you may be able to borrow from these plans tax-free up to certain limits. You can also tap into your retirement plan early and without penalty by taking a series of substantially equal payments. Keep in mind that money you withdraw from your retirement account to pay for your child's education won't be there to fund your own retirement. Take a look at our detailed guide to retirement here.
Savings Bonds For Education
The tax on interest from Series EE and Series I U.S. Savings Bonds is waived when you cash them in and use the proceeds to pay for eligible educational expenses at qualified schools i.e. schools that qualify for federal student aid programs. The benefit is limited by incomes above certain thresholds. The bonds should be issued in the parent's name(s), not the child's. You can buy up to $10,000 in bonds per year. The downside of this method is that, at least currently, savings bonds are paying very little interest.
Students may receive grants and scholarships to help pay for college or a career school. This is free money that reduces the amount a parent must provide to help pay for education. Grants are needs-based, while scholarships are merit-based. Aid is available from the federal and state governments, schools, and private or non-profit organizations.
To apply for federal student aid, the student must submit a Free Application for Federal Student Aid (FAFSA) that lists financial information and sources of assistance to the student. Federal grants are distributed on the basis of eligibility criteria that include:
- Financial need
- Registration with Selective Service
- Enrollment in an eligible school, at least half-time
- Maintaining satisfactory academic progress
- High-school diploma or equivalent
The federal government also offers 2 programs, the American Opportunity Credit and the Lifetime Learning Credit, that allows you to claim $2,000 to $2,500 per student per year for eligible educational expenses.
The amount of aid a student will receive is based upon a byzantine series of regulations that take into account a parent's "expected family contribution," which in turn depends upon family income, savings plans, college costs and so on. The information included in the FAFSA is used to determine the amount of aid a student will be offered. Some strategies parents can take to reduce their expected family contributions include:
- Postpone taking Social Security benefits, if applicable
- Postpone taking capital gains on stocks, bonds and other investment
- Take capital losses on investments
- Rent income is often excluded because depreciation can wipe out the profit (on paper) of renting the property
- Tax-deductible contributions to retirement plans are added back for purposes of calculating aid, and that's a bad deal.
- If you own a small business, its value is not included when calculating aid.
Student loans help parents by reducing the amount they must contribute to their children's education. Naturally, parents can choose to help their children pay off the student loans when they become due. This can be a useful tactic if the parents are expecting to be wealthier in the future than they are now.
In addition, parents can apply for a PLUS federal student loan if their children are undergraduate attending school at least half-time. The parent, not the student, is responsible for paying back the loan.
The 2 types of student loan programs are:
1. Federal student loans: These are funded by the federal government, and include Direct Subsidized Loans, Direct Unsubsidized Loans, Direct Plus Loans (for graduate and professional students or parents) and Federal Perkins Loans.
2. Private student loans: These are non-federal loans made by a private lender such as a bank, school, state agency or credit union.
Federal student loans have several advantages over private loans:
- They do not have to be paid back while attending school at least half-time
- The interest rates are fixed and low
- Undergraduates currently attending at least half time and with financial need can qualify for subsidized loans in which the government pays the interest
- No credit check is required
- Student's don't need a co-signer
- Interest may be tax deductible
- Loans can be consolidated to reduce monthly payments
- There are several repayment options, including 1 which is tied to the student's income
- No prepayment penalty
- Loan forgiveness is possible in exchange for public service work
Federal student loans are accessed via the FAFSA.
If you have already taken out student loans to pay for your child's education, but are experiencing difficulties in repaying the loan, you may want to check if you are eligible for student loan forgiveness.
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