4 common questions — and answers
By Rev. James R. Cook, CFP®
The thought of preparing for your child’s college education can be daunting. There are so many questions: How much do I need to save? When do I need to start? What are my options?
Here, we tackle four common questions about college planning.
Q: When should you start saving for college?
A: Like most savings and investing goals, starting early is one of the most important steps you can take to reach your goal. Time allows your investment to reap the benefits of compound returns. For example, if you can earn 6% on your investment, and you want to save $80,000 when your child starts college at age 18, you would have to save $207 a month if you started when your child was born.
If you wait until they are 10 years old, you would have to save $651 a month in order to have $80,000 by their 18th birthday.
You need to be realistic about your timeframe. Are you saving for 18 years, eight years, or eight months?
Make a plan to start saving today with whatever amount you find comfortable. Review your budget on a regular basis; see where you can tighten your belt, and increase what you are saving over time. Arrange to make automatic deposits from your bank account to develop a disciplined approach to saving and investing.
Q: What are some college savings options?
A: Once you have decided to save for your child’s future college education, you need to decide where to invest your money. One of the best vehicles is the Section 529 Plan. These plans fall into two categories.
The first is a pre-paid tuition plan. Most of these are state-sponsored plans that allow you to lock in future tuition at a state institution at current rates. The downside of a pre-paid tuition plan is that your child can only attend state-sponsored educational institutions.
The second type of 529 plan is a qualified tuition plan in which money is placed in an account for qualified future education expenses. These accounts are designated for a specific individual, and may be used at any school. One benefit of this type of plan is that assets grow tax-free; also, distributions from these accounts are not taxable.
Most states and some investment companies offer 529 plans. Typically, they are invested in mutual funds. Another benefit of this type of plan is that contribution limits are very high, ranging by state from $235,000 to $475,000.
A similar type of savings model is the Coverdell Education Savings Account, or ESA. The tax structure is similar to the 529 plans — earnings are tax-deferred, and qualified distributions are tax-free. These accounts must be established for and funded for an individual prior to age 18. Further, the annual limit for contributions to these plans is capped at $2,000.
You can also invest your money in stocks, mutual funds, or any other type of investment that you deem appropriate based on your investment expertise and investment timeline. The downside is that you will likely pay a sizable portion of any growth or income that your investment generates to taxes.
Q: What other funding options are available?
A: Another option is to enlist the help of other family members. A 529 plan can be opened and funded by anybody on behalf of a future scholar. Reach out to grandparents who might consider opening up a 529 plan for each of their grandchildren and investing half of what they would normally spend on birthday or Christmas gifts.
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The rising cost of education means that many students graduate with substantial debt. For some, this is an unavoidable cost that they take on to secure their future. There are several types of loans available for students.
Perkins loans are a type of federal loan that is administered by colleges. These loans are need-based, and interest does not accrue until nine months after the student leaves school, at which time repayment must begin.
Stafford loans are another form of subsidized federal loan based on need. There are also unsubsidized Stafford loans that are not need-based. The government pays the interest on the subsidized loans until six months after the student leaves school. Unsubsidized loans begin to accrue interest within 60 days of the disbursement of funds, but payments are not required until the student leaves school.
PLUS loans (Parent Loans for Undergraduate Students) — Unlike the two previous loan types, PLUS loans are loans for parents, rather than for the student. These loans are made directly by the federal government and are not need-based. Interest begins to accrue immediately, but payment may be delayed until the student leaves school.
Q: Is it a good idea to dip into your retirement account to pay for college tuition?
A: As important as your child’s educations is, there are ways of funding it that do not involve risking your own financial future. There is a tried-and-true axiom in financial planning, “You can borrow to put your kids through college, but you can’t borrow to put yourself through retirement.”
Dipping into your retirement savings has potential tax consequences if the funds are tax-deferred. More important, drawing on those funds depletes them, as well as future earnings on them. It is wiser to focus on the funding sources we have already discussed.
Rev. James R. Cook, CFP® is Senior Manager, Large Employer and Mergers and Acquisitions, at MMBB Financial Services. Rev. Cook focuses on business development and offers expertise in comprehensive financial and retirement planning.