Saving for Higher Education
Part 1 – Six Options for Savings
Your children’s education may be the most cost-intensive purchase you ever make. A family of three children that all attend private universities will likely pay close to $1 million for their degrees. No matter your personal financial objectives or your children’s choice of school, establishing a sound plan to save is of critical importance.
Cost of Education
College tuition costs are skyrocketing. According to The College Board ®, a not-for-profit corporation, the average tuition increase from 2016-2017 was 3.6 precent at private institutions and 2.4 percent for public institutions. The only potentially good news is that the rate of increase appears to be slowing.
The decision of how much you are able and willing to save should be determined based on your personal objectives and available resources. Once you decide how much to save, you have several options each with their own advantages and disadvantages:
#1 529 Savings Plan – These are state-provided investment plans in which investment earnings and withdrawals are tax-free as long as they are used for qualified educational expenses. Certain states, such as New York and Pennsylvania, allow you to deduct contributions to these accounts for state tax purposes. Unfortunately, the investments in these types of accounts are limited and do not always generate the best returns.
#2 General investing – This is simple; all you need to do is fund the account and invest. You can then use the funds for any purpose including education. With this type of account, while you have nearly unlimited investment options, you will need to pay taxes on the earnings so be sure the money is managed in a tax-prudent manner.
#3 Coverdell Savings – These are accounts to which individuals whose income is below $110,000 ($220,000 if filing jointly) can contribute up to $2,000 per year. Because of these contribution limitations, and because there is no tax deduction for contributing, many investors tend to focus more on 529’s and general investing.
All of the options above involve investing additional cash from your other savings or income. If, however, you do not have a great deal of spare income, you can consider the following:
#4 Home equity – While it is common for families to utilize their home equity, we urge caution particularly when your personal retirement plan is pinned to the value of your home. Home equity values are not always stable so before you withdraw funds, make sure that your loan-to-value ratio is in an acceptable range and that you have the means to pay back the additional debt.
#5 Whole life insurance – If you already have a whole life insurance policy with substantial cash value, you can consider borrowing against that balance to help pay for education costs. Note, however, that the funds must be paid back or you will pay taxes on the earnings from the amounts withdrawn. This approach is less than ideal.
#6 IRA’s – Unless there are specific mitigating circumstances, we generally advise that you do not withdraw funds from IRA’s to pay for education. While it is true that funds withdrawn from IRAs that are used for qualified educational expenses are not subject to the 10 percent early withdrawal penalty, any amounts withdrawn are subject to income tax.
Begin your savings plan as early as possible: The power of compounding will enable you to grow your education savings so that you can ultimately pull fewer funds from your other objectives. Keep an eye out for part two on this topic when we will discuss educational loans and strategies that you can employ!