In 2009, college students graduated with an average $24,000 in debt. Unheard-of in previous generations, this kind of debt burden is now commonplace.
Why? Because the cost of essentials is rising and in a global economy, a college education is becoming a necessity. The price of college has been rising faster than inflation and pressure on families to cover their children`s college expenses also has grown. In the last 25 years, federal student-aid grants have waned in favor of high-interest loans. `How much to borrow?` is now a standard feature on all needs-analysis college cost calculators such as www.collegeboard.com/student/pay/add-it-up/401.html. This default to debt in student financial aid may shadow and stress a graduate`s early adulthood and potentially could jeopardize his or her ability to save. Borrowed money must be repaid, after all, and with interest. Don`t give your child the kiss of debt. Plan ahead and make sure that he or she has the money needed for post-secondary education.
How? Estimating the projected costs of a college education is the first and probably most important step. Is your child likely to attend a public or private university? In-state or out-of-state? Study today`s costs at colleges that your child will be likely to attend and apply a growth rate of 7 percent to 8 percent annually between now and the autumn your child is scheduled to enter college.*
Once you know the sum needed, the next challenge is to find a way to meet it. Your goal is to build assets for later without producing taxable income now. A savings account is not likely to generate the long-term rates of return to produce the money required to cover overall costs. You need a more sophisticated instrument that takes advantage of systematic savings. Here are some of your choices:
Mutual funds may offer a good start, but diversifying and rebalancing them are key for college savings. To avoid heavy taxes on long-term earnings, avoid high-income investments. Additionally, buy funds, for example, that produce a small dividend because you seek appreciation, not dividends. That said, the risk level of a mutual fund portfolio geared toward college savings should shift from aggressive to conservative as the child nears and enters his or her college years.
Earnings in state-sponsored 529 plans grow tax-deferred, and when used for qualified higher education costs, they can be withdrawn tax-free. Earnings not used for higher education expenses are subject to taxation and a 10 percent penalty.** The owner controls the account and decides when withdrawals will be made and for what purpose. The owner can reclaim assets for any reason. This way, there`s a limited chance that the child can use the money toward a non-educational expense. Details vary from state to state; read the fine print.
The Coverdell Education Savings Account allows nondeductible contributions of up to $2,000 annually per beneficiary. Earnings are not taxed, and as long as withdrawals are used for qualified education expenses, they are tax-free as well. Assets must be used before the beneficiary`s 30th birthday. A special feature allows withdrawals to be used to pay for elementary, secondary or college education. This is a key differentiation from 529 plans.
Custodial accounts under the Uniform Gifts to Minors Act (UGMA) or
Uniform Transfer to Minors Act (UTMA) offer contributors both income tax breaks and estate tax breaks. But these are not recommended as a form of assured college savings because when the minors for whom they are intended reach the legal age of adulthood, they can spend the money any way they choose.
*Source: The College Board
** Earnings on non-qualified payouts will be subject to income tax and a 10 percent federal penalty tax. College savings plans offered by state governments vary significantly in features and benefits. The optimal plan for each investor depends on his or her individual investment objectives and circumstances. If your state, or your designated beneficiary`s state, offers a 529 plan, you may want to consider what, if any, potential state income tax or other benefits it offers before investing. Investors should consider the investment objectives, risks, charges and expenses of the 529 plan and underlying funds before investing. This information may be found in the plan`s Offering Statement. Read the prospectus and Offering Statement carefully before investing.