This is the first of a two-part series on options and strategies for saving for your kids’ college education. The second part will run next week.
“We’ve saved exactly nothing for our children. We meant to though. We saw those commercials with couples and their babies talking about their college financing plans. That was who we were going to be. But six years later — zippo! Sorry, kids, your parents are procrastinators. There were bills to pay: the mortgage, day care, home repairs, our own student loans, etc. And, yes, frivolous things, too, like cable television, the occasional meal out and, oh my, did we really spend that much at Whole Foods?”
Joe Heim, editor and writer for The Washington Post magazine
If you are a U.S. middle-class family, it will cost you about $304,000 to raise a child born in 2013 to age 18 — and that doesn’t include education after high school. Most American families don’t have a plan for paying for college. In fact, 2013 stats reveal that only 36 percent of middle-income families and 29 percent of low-income families have set aside money for college, and this number continues to decline. Yikes.
Saving for college has its merit, but having a short-term emergency plan (five to nine months of savings in the bank to cover expenses in case of sickness or job loss) and a long-term retirement plan must be done first. There are many ways for students to get financial help for college, but there is no financial aid for retirees.
The average cost of college continues to rise and runs between $200,000 for a public university to $400,000 for a private university. If you start saving early, you have a better chance of being prepared. If you put away $100 a month in a mutual fund for your child at birth, the portfolio could be worth $47,000 by the time he/she turns 18. In contrast, if you wait until the child is 10 to start saving but put away $225 a month, the portfolio would only be worth about $30,000 by the time he/she turns 18. In both situations $21,600 was invested, but one had time on its side. You can get a big bang from modest savings if you give it enough time to grow through compounding.
Here are some methods you can consider to make sure your educational investments grow with your children.
Education Savings Account (Coverdell ESA)
An ESA is a tax-advantaged investment account created for people to save for future education expenses. An ESA allows people to deposit up to $2,000 per year for an eligible child without being taxed on earnings — as long as the child uses the funds before the age of 30 for qualified educational expenses. The account must be started and all contributions made before the child is 18.
The tax considerations of Coverdell ESAs are similar to 529 plans (tax-deferred growth and tax-free withdrawals for qualified education expenses at qualified institutions), but where 529 benefits focus on colleges/universities, ESA benefits include primary and secondary school, in addition to college and universities.
Section 529 Plans
The Florida 529 Savings Plan allows you to choose from various investment options for your child. After an initial contribution of $250 or automatic deductions of $25/ month, how much /how often you contribute is up to you. The 529 plan covers the usual educational expenses (funds may be used for room and board if they qualify). You can use the plan wherever and whenever you want. If the child doesn’t use the funds, the plan is transferable to another eligible student or you may close and withdraw the funds (subject to IRS taxation depending on how the funds are used).
The upside? You can save up to $300,000 per child and as long as the withdrawals are used to pay for college, they are tax free. The downside? Some plans come with fees. And depending on the market, if your investment doesn’t perform well, you could lose money. For more information see www.collegesavings.org
Several states, including Florida, offer prepaid tuition plans that freeze tuition rates at their current level. Compared to investing in the market, prepaid tuition plans are virtually risk free — you won’t lose your money if the market declines. However, they are often limited to in-state residents.
The biggest difference between the prepaid plan and the Florida 529 Savings Plan is that the 529 plan is subject to fluctuations in the financial markets, while the Florida Prepaid College Plan is guaranteed by the state. The Florida Prepaid College Plan provides various programs with options on costs, payment schedules and benefits. The plan is designed to be used toward tuition and most registration fees at either a Florida college or state university, but the amount covered by the plan can also be applied to other schools nationwide. The plan you purchase is good for 10 years from the projected college/university enrollment date.
Parents or guardians who have been a Florida resident for the previous 12 months can enroll a child from newborn to 11th grade during the fall/winter enrollment period. If your child receives a scholarship, the amount covered by the prepaid plan can either be refunded or applied toward tuition or fees not covered by the scholarship. And like the 529, if your child does not go to college, the equity in the plan can be refunded or applied to another eligible student.
The Roth IRA is a great retirement investment tool, but what many people don’t realize is that it can also help you cover your child’s college bill. Roth IRA deposits receive no tax deduction, but they grow tax-deferred. The upsides of Roth IRAs are that withdrawals are exempt from withdrawal penalties if the funds are used specifically for qualified educational expenses and they offer flexibility over the 529 plan in that if a child does not end up attending college, the money can be converted into retirement income (money saved in the 529 plan not used for educational expenses becomes fully taxable and subjected to a 10 percent penalty). The downside to Roth IRAs is there are contribution limits. For 2014 the maximum contribution is $5,500 ($6,500 for people over 50). Also, people with high incomes are prohibited from participating. A single taxpayer with an income over $114,000 is not eligible for a Roth IRA; married taxpayers are phased out at $181,000.
Investing in stocks or bonds with after-tax income provides maximum flexibility and the potential for high returns over the long term. Since college tuition rises faster than inflation, stocks (either individual or as a mutual fund) continue to be the best investment to help your education savings keep pace. There is always the risk of a market turn just as your child nears time for college. Whatever you do — either individual stocks, bonds or mutual funds — keep the investment simple and aim for companies that have good three- to five-year track records. You can set up automatic withdrawals from your bank account or paycheck to feed your investments — it’s a great way to force yourself to save.
Parents of kids younger than 8 should place 60 to 95 percent of their assets in stocks. Ameriprise financial advisor Dawn Jurkovich suggests putting money in moderately aggressive investments and in investments with a higher dividend. The money can be used for college tuition, living expenses, weddings, or anything else.
Parents of kids 9 to 13 should redirect new investments into bonds and stable stock funds, while parents of kids over 14 should shelter their gains by either moving assets into a money market or short-term bond funds for the remaining four years. This way you can cash out quickly by the time your child is ready for college.
U.S. Series E Savings Bonds are risk free and can be stored away in your safety deposit box until it is time to pay for your child’s education. The tax break with savings bonds is limited to parents who meet income limits. For more information go to http://www.savingsbonds.gov
Laurie Futterman ARNP is a former Heart Transplant Coordinator at Jackson Memorial Medical Center. She now chairs the science department and teaches gifted middle school science at David Lawrence Jr. K-8 Center. She has three children and lives in North Miami.