The evidence is clear: Having a college degree really pays off. College graduates typically earn about $1 million more in their lifetimes than high school graduates do, say experts at Georgetown University’s Center on Education and the Workforce.
How to afford the rising cost of college, however, is a bit less apparent. You’ll definitely need a specific savings goal and a plan for getting there. The good news is that it’s never too late to begin securing your child’s future.
Here are answers to 8 important questions to guide you through the process.
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1. How much will I need to save?
You need to consider the cost of college at the time your children will enroll. Many organizations offer personalized calculators — such as this Education Funding Planner by OppenheimerFunds Inc. — that enable you to enter your child’s current age, estimated start date, and one or more potential schools to obtain customized cost projections.
2. When should I begin saving?
That same Oppenheimer planning tool will also show you how much you need to sock away depending on when you begin. Just remember the earlier you start, the more potential you have to save.
Example: Parents who begin socking away $200 per month soon after a child is born could amass almost $70,000 in a tax-advantaged savings account (assuming a 5% annual rate of return and 28% tax bracket) by the time the child is 18 years old. If the parents waited until the child was 12 to begin saving, they would have to put aside more than 4 times as much each month — and invest almost $7,000 more — to save a similar amount in time for college.
3. I hear so much about 529 plans. Why are they such a good way to save?
People appreciate how 529 plans let your savings grow tax free. Earnings in the accounts avoid federal tax completely if withdrawals are used for qualified college expenses. (Use the money for noncollege expenses, though, and you’ll owe both taxes and a penalty on earnings.)
What’s more, many states give residents a tax deduction or other tax break for 529 contributions. Residents of Illinois, for example, can deduct up to $10,000 if single ($20,000 if married) in annual contributions to the state’s plan on their Illinois tax return. You’ll also pay no state tax on earnings and withdrawals that cover qualified expenses.
The flexibility and simplicity of the accounts are big selling points as well. Parents can use the funds for qualified expenses such as tuition, fees, room and board, books and even equipment in some cases. They can also use them at just about any kind of secondary education institution imaginable, including trade schools, private or public institutions, 2-year and 4-year programs, community colleges, and some international schools. And if your kid chooses to skip college? You can easily change the designation to a sibling.
Choose between various portfolios of stock and bond investments, make contributions, and sit back while the state or a third party, such as an investment firm, manages your funds. The Illinois Bright Start 529 Program, for instance, is managed by OFI Private Investments Inc., an Oppenheimer subsidiary.
One more unique advantage: Contributions to 529 plans are excluded from an account owner’s estate when taxes are assessed, making them an attractive option for grandparents who want to help fund a grandchild’s education.
4. How much can I contribute to a 529 plan?
There are no income or annual contribution limits for 529 plans. However, the lifetime amount you can contribute varies by state. Open an Illinois Bright Start account, for example, and you can contribute up to $350,000 per child.
Don’t forget that you’ll pay federal gift taxes on annual contributions above $14,000 ($28,000 for married couples).
5. What is the difference between a 529 plan and a Coverdell account?
Coverdell accounts are similar to 529s. The money grows tax deferred and avoids tax if you use them for qualified education expenses.
They do, however, have income caps and much lower contribution limits. To make any contributions, you must have a modified adjusted gross income of less than $110,000 as a single filer and $220,000 as a married couple filing jointly. What’s more, the current annual limit on contributions per child is only $2,000.
In addition, the account must be used by age 30 or rolled over to another beneficiary. And there are no state tax advantages.
6. Does it make sense to use my Roth IRA savings?
Roth IRAs are a great fallback fund for education because they provide tax-free growth that you control. You also avoid the 10% early (under 59½) withdrawal penalty on earnings as long as you use the money for qualified educational expenses.
Of course, the downside is that any withdrawals will reduce your retirement nest egg.
7. Does anybody use custodial accounts anymore?
Once a popular option, custodial accounts — known as UGMAs or UTMAs, for the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act, respectively — have largely fallen out of favor.
These accounts let you put money or other assets in trust for a minor child and, as trustee, manage the account until the child reaches legal age in your state. The big drawback? At that age, the young adult owns the account and can use the money for whatever he wants.
Another disadvantage: Because custodial accounts count as student assets, large balances can reduce financial aid.
8. How do I get started?
Anyone can open a 529 plan. To enroll in the Illinois Bright Start plan, account owners don’t even have to be residents of the state. All you need is $25 and a valid Social Security number for both you and your future college student
To learn more about Bright Start, visit www.brightstartsavings.com.
This content was provided by Bright Start. Kiplinger is not affiliated with and does not endorse the company or products mentioned above.
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