Parents often ask what is the best way to save for college. Before answering this question, it is important to remember you can always borrow for college, but you can’t borrow for retirement. Be sure you have your retirement funding in order before saving for college.
If your children are years away from college consider yourself fortunate and start saving for college now. To begin the savings or investment process for college, you must first define your financial goals or the specific amount of money that is needed to fund education costs. To determine the amount of money you need to save or invest, go to the College Savings calculator at collegeboard.com.
Once you have determined the amount of money you wish to save for college, you can begin the investment or savings process. The key is to get started, even if the monthly or weekly amount is small. Since one of the most important factors is the amount of time available to save, you should start saving as soon as possible. The earlier an investment plan is implemented, the greater the investment options. Also, if you start early you’ll be able to invest a smaller annual contribution to meet your saving goal.
An important factor to address is whether your child will qualify for financial aid. To determine this, calculate the Expected Financial Contribution (EFC). For families with children who are not yet in college, we assume that if they qualify for financial aid now, they will qualify for financial aid in the future. If your child would qualify for financial aid, it might not be advisable to save for college in the child’s name because the child’s assets are assessed at a higher rate. However, there are times when the tax benefits you receive as a parent outweigh the financial aid benefits that could potentially be received by your student, especially at a public university. You have control over the tax benefits, although you have no control over how much financial aid the college will award. The majority of the financial aid received at public universities is loan and work study. On the other hand, the majority of financial aid at private universities is gift aid.
You will need to select the appropriate investment vehicle to invest the funds. There are several education investment options that should be considered, such as Coverdell Education Savings Accounts, Qualified Tuition Plans, or tax-efficient mutual funds. It is important to understand the pros and cons of each type of investment in order to select the appropriate investment or combination of investments.
To select the appropriate investments for the education funding plan for your child, consider your child’s eligibility to receive financial aid. If your child is expected to be eligible for financial aid, use investments that will not reduce his or her financial aid eligibility. These types of investments would include retirement accounts, annuities, and life insurance. Before investing in life insurance, it is important to make sure it is applicable to your situation. Sometimes insurance products are sold under the premise that it is used to reduce EFC without doing actual analysis to see if the strategy is valid for the consumer. If other types of investments are selected, hold them in the name of the parents because of their lower financial aid asset assessment rate.
If the children are not expected to be eligible for financial aid, the Coverdell Education Savings Account (CESA) is usually a good first choice because it can be used for either K-12 expenses or college expenses. It also offers the parents direct control of the investment and the flexibility of being eligible to be rolled over to a Qualified Tuition Plan (QTP) at a later date.
After the CESA has been funded, the QTP should be considered as a college funding vehicle. If there is a state tax incentive for contributing to these plans, the parents should fund the QTP to the level needed to take advantage of the state tax incentive. However, because of the harsh tax treatment of QTP withdrawals not used for college (ordinary tax rates and 10% penalty on the earnings portion of withdrawals not used for college), the parents should not over-fund a QTP. They may want to contribute only enough to cover the cost of a public college education.
The final level of college funding for children that are not expected to be eligible for financial aid should be into tax-deferred investments. Suitable investments include tax-efficient funds, Series EE Bonds, I Bonds, and municipal bonds. If the parents want to keep control of the investments, the investments should be titled in the parent’s name.
Your Financial Watchdog, LLC provides online affordable, easy-to-use financial tools for individuals. http://www.yourfinancialwatchdog.com/tools/college_toolkit.php
