College Keeps Getting Pricier — Here’s How to Prepare
April 9, 2020
It’s no secret that college is expensive. In the 1970s, when a lot of our clients were attending school, tuition was in the area of $2500 to $3500 per year. Now, that number is roughly ten times higher.
If you have kids or grandkids that might be starting college in the near future and you want to help them out with tuition, that can add up pretty quickly. And that’s just classes and lodging — between living expenses, supplies, books, and everything else, a four-year college experience can easily run into a quarter of a million dollars, and most people don’t have that lying around in liquid funds.
So what’s the best way to plan for tuition costs? We have some ideas.
Think About What You’ll Need Later, Not Now
If you’re putting money away now to save for college and not planning to use continuous contributions as you would with a retirement fund, you’ll need to know what you expect to spend.
In recent years, tuition and fees at private nonprofit four-year institutions has gone up roughly two percent per year. If you’re anticipating paying for tuition in ten years, today’s tuition prices may increase by more than a third, so you’ll need to anticipate that.
One step that not many people know about is pre-paying for tuition. These plans don’t apply to every state and every school, but there are financial plans that allow you to lock in a tuition price at the moment you start the plan, then pay in over time, mitigating the rising costs of tuition and inflation, ensuring that you know exactly what you’ll pay.
Of course, you’re taking a gamble by prepaying. You don’t know whether the kid in question will want to go to that school, or even go to college. Teenagers are unpredictable, and it’s a lot of money to be tied to one option. There’s also the fact that you could take that six-figure sum, put it in a brokerage account, and probably get much better returns on it, then pay for college plus a little extra.
What You Need to Know About a 529 Plan
The go-to college savings option is a 529 plan, named after section 529 of the IRC. Money that you add to a 529 is tax-deferred, and the funds aren’t taxed on withdrawal as long as they’re spent on higher education, including tuition, student loans, computers, and a couple of other small categories. You can pay into a 529 all at once or slowly and know that it’s not going anywhere — and better yet, the IRS isn’t taking any of it at either end.
The benefits of a 529 are substantial:
- Contributions aren’t deductible, but earnings grow tax-free and aren’t taxed upon withdrawal. In addition to federal tax savings, many states offer their own tax deductions or credits on 529 plan contributions. If you don’t like the benefits offered by your state, you can set up a plan in any other state and still use it at the qualified school of your choice.
- The beneficiary of a 529 doesn’t have any control over the account, so you can be assured that it will be used for the intended purpose. If the beneficiary decides not to go to school or wants to attend a cheaper school, they can’t just take the money for their own purposes. You can even withdraw the money yourself if you want, but you’ll be charged tax on non-educational withdrawals as earned income, in addition to a 10 percent penalty.
- A 529 is almost completely hands-off. Once you set up the plan and link your bank account with an automatic investment, the management of the account is out of your hands, taken care of by the program manager or the state treasurer’s office. You do have some say over how your plan is invested and can change those options twice a year, but you can also just leave it until it’s needed.
- Anyone is eligible for a 529 plan. There are no income, age, or annual contribution limits, so you can add as much or as little as you want every year. There are lifetime contribution limits to keep in mind, which vary between plans from $235,000 to $520,000 — if you’re trying to plan for an especially expensive school or post-graduate education, you might need a plan with a higher lifetime limit. You can also treat a contribution between $15,000 and $75,000 as though it were made across a five-year period, potentially reducing your tax bill.
It’s not all good news. If you set up a 529 for someone who doesn’t go to college at all, you’ll have to withdraw the money and pay the full income tax on it, in addition to the 10 percent penalty. That’s why some parents and grandparents opt to use a brokerage account and take their chances with capital gains tax.
Don’t Forget About FAFSA
Lots of high-net-worth parents assume that they won’t be qualified for federal student financial assistance, so they don’t even bother applying. That’s a mistake. Most merit-based scholarships still require you to fill out a FAFSA application, so it’s crucial that you fill that application out to ensure that you don’t miss the deadline on other scholarship opportunities.
Talk About Your Options
Obviously, there are a lot of ways to set aside several hundred thousand dollars over the next ten years — you could set up a normal brokerage account, contribute to a trust and name the future student as the beneficiary, create a series of CDs, or any number of other investment vehicles.
At First Western, we know that there’s no such thing as a cookie-cutter investor, which means there’s no such thing as a cookie-cutter plan. Check out our financial planning guide or talk to one of our expert financial advisors and we’ll come up with a plan that’s tailored for your finances, your priorities, and your unique situation. Get in touch today!