With the continual growth of the higher education bubble, talk of financing college is no longer a seasonal topic but a year-round one. While median household income growth between 2005 and 2015 was 0.4% (adjusted for inflation), the cost of college tuition and fees for a 4-year public college increased 3.5% during that same time. When the cost of those same schools average about $10,000 a year, many families are left wondering how they’ll afford college.
How can families fight escalating costs and still put their children through school? There are several ways to prepare for and pay for college. Visit here for non-traditional ideas to help cover college costs. Some are more common than others. Here we’ll discuss four traditional ways to prepare for and help pay for college.
529 Pre-Paid Tuition Plans or Qualified Tuition Program
529 Pre-Paid Tuition Plans are offered by each state, including Washington DC, and lock in current tuition rates to cover future college expenses. This lets families buy shares of tomorrow’s tuition in today’s dollars. Students who go to in-state schools receive the full benefit of these state-level programs and in-state schools are usually cheaper than out-of-state schools to begin with.
If students do go to an out-of-state school, their home state will often pay the equivalent cost of going to an in-state college. Therefore, families only need to make up the difference between the expenses of an in-state school and the out-of-state school.
Also, if you try to qualify for financial aid (which we’ll cover later), 529 Pre-Paid Tuition Plans have minimal effect on student financial aid qualification.
Uniform Gift to Minors Act / Uniform Transfer to Minors Act (UGMA/UTMA)
UGMA/UTMA accounts are custodial accounts that let a custodian invest the money contributed to these accounts as they think best for the beneficiary minor. These investments can include stocks, mutual funds, exchange traded funds (ETFs), cash, and bonds. Those under the age of 18 aren’t permitted to invest. UGMA and UTMA accounts, therefore, let minors indirectly invest via an adult custodian.
The UGMA/UTMA contribution limit for 2017 is $13,000 for individuals and couples who are married and file separately. For couples who are married and file jointly, the contribution limit is $26,000.
Capital gains of $900 or less per year within UGMA and UTMA accounts are not taxable. Capital gains between $901 and $1,800 are taxed at the minor’s marginal income tax rate, which is typically much lower than the custodian’s tax rate. Capital gains over $1,800 are taxed at the custodian’s tax rate.
One benefit of UGMA/UTMA accounts is that the money invested the money invested in isn’t required to only be used for college expenses. Once a child reaches the “age of majority” in their home state, custodians must turn over the assets in UGMA/UTMA accounts to the minor.
At this point, the former minor may do with the funds as they wish. The age of majority varies by state, but for most, it’s age 18. Handing over $20,000 to some 18-year-olds could be precarious, which is why we always say it’s important to teach your children financial literacy and responsibility from a young age.
It’s also important to note that these accounts are considered assets of the beneficiary, and therefore they do impact a student’s qualification for financial aid.
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Coverdell Education Savings Accounts (ESA)
An ESA account allows for a $2,000 maximum annual contribution with the benefit that the account grows tax-free. Distributions taken from the account must be used for qualified education expenses; otherwise, taxes and penalties apply.
As with UGMA/UTMA accounts, contributions to Coverdell ESA accounts can be invested as a custodian wishes. Likewise, the custodian must hand over assets in an ESA to the beneficiary once the beneficiary reaches the age of majority in their home state.
529 Savings Plans
529 Savings Plans are different than 529 Pre-Paid Tuition Plans and have been the most popular types of education savings accounts. The popularity of these plans is because of the combination of its higher contribution limits and its flexibility. Students aren’t restricted to colleges or universities within the state that sponsors their 529 Savings Plan.
The flexibility of 529 Savings Plans is that they may be transferred to another beneficiary if the original beneficiary doesn’t pursue a higher education or doesn’t use all the money in their 529 Savings Plan.
Like 529 Pre-Paid Plans, 529 Savings Plans are also state-sponsored plans. Maximum account contributions, however, are not to exceed the qualified education expenses of the beneficiary. That said, the gift tax may apply to contributions that exceed $14,000 a year per donor per recipient.
Earnings in 529 Savings Plans aren’t federally taxed and aren’t typically taxed by the state offering the plan. However, contributions are not tax deductible. 529 Savings Plans do affect a student’s qualification for financial aid.
These means of paying for college require time and consistency. The earlier and more regularly a family contributes to any of these accounts, the better. It’s advisable for parents to open such accounts when their child is born. It’s a good idea to ask friends and family on occasion to contribute to the accounts the family opens in lieu of birthday, holiday, and other gifts to help with saving money for college.
This leads us to 7 Non-Traditional Ways to Make College Savings Less Painful and More Profitable, which includes some creative ways to have someone or something else help cover the cost of college.
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