How to save for your child's college fund

With the cost of a college education continuing to rise every year, saving enough money to send your kids to school can feel like a daunting task. On average, paying for tuition, books, and living expenses will cost you over $35,000 per year as a student attending college in the U.S.

The U.S. Department of Education offers a net price calculator to help you estimate the cost of colleges around the country to determine how much you may need to save. If you’ve begun researching different ways to pay for a child’s higher education, you’ve likely come across a long list of options. Let’s take a closer look at some of the available savings strategies and how parents and grandparents can use them to help fund a loved one’s academic future.

Grants & scholarships

A common type of financial aid or gift aid where students can be awarded money to help with the cost of higher education is through grants and scholarships. Grants are often awarded based on a family’s financial situation and scholarships are typically based on merit, whether academic, athletic, or activity based. To apply, you will likely need to fill out financial aid forms, such as the Free Application for Federal Student Aid (FAFSA), or follow the specific application process for the individual scholarship. Free online resources like the College Board’s Scholarship Search can help you find matches based on your child’s interests and affiliations. Sources of grants and scholarships include:

• Government: The federal government offers need-based financial aid in the form of grants and state governments often have scholarships and grants for residents planning to attend school in their state.
• Private organizations: You can often find private college funds through foundations, clubs, community organizations, and churches.
• Colleges and universities: The institution your child chooses to attend often offers scholarships and grants for their students.

529 plan

When researching college savings options, 529 plans are frequently on the list. This tax-advantaged savings plan can help people set aside money for a college education and school-related expenses. Similar to how a 401(k) or IRA works, these savings plans allow you to invest your contributions in mutual funds or similar investments. Your money can grow tax-free and allows you to save for a child, family member, or even for yourself. Each state offers its own 529 plan, and several private colleges and universities offer plans too. Savingforcollege.com provides a 529 plan comparison tool that allows you to filter plans and identify the ones that closely match your needs. You can choose from two types of 529 plans:

1. 529 college savings plan: With this most common type of 529 plan, your investment grows on a tax-deferred basis, and funds can be withdrawn tax-free to pay for expenses like tuition, textbooks, and room and board.
2. 529 prepaid plan: This type of 529 plan allows you to prepay all or a portion of the costs to attend an eligible public or private college or university. You can “lock in” today’s tuition rates and make payments in one lump sum or through installments. This type of plan only allows funds to be applied to tuition and fees and does not cover other expenses like books and room and board.

Coverdell education savings account

A Coverdell education savings account (ESA) is a trust or custodial account where the beneficiary can use funds to pay for qualified education expenses. These accounts can be opened for any child under the age of 18, and assets must be withdrawn by the time they turn 30 years old. Like a Roth IRA, you can make a non-deductible contribution each year, and similar to a 529 plan, Coverdell ESAs offer tax-free investment growth and tax-free withdrawals when money is used to pay for qualified college expenses.

College savings bonds

Issued by the Treasury Department, college savings bonds, also known as Federal Savings Bonds, have long been a popular choice for grandparents to help start up a college fund for their grandchildren. A savings bond is considered a very low-risk investment, where the money cannot lose principal, and since it is designed for a child to access when they’re older, withdrawing funds when a child is young is often difficult. When the big day arrives, the beneficiary can either cash it out or roll funds into a 529 plan. If the cash in the bond is used for college expenses like tuition and books, you will not need to pay taxes on the interest.

Roth IRA

Saving for retirement likely comes to mind when you think of a Roth IRA, but it can also be used to help pay for qualified college expenses. Contributions to a Roth IRA are made with after-tax dollars, where annual amounts are limited each year. Normally, if you withdraw earnings before you reach age 59 ½, you will have to pay a 10% early withdrawal penalty, but if these withdrawals are used for qualified education expenses, you can avoid paying this fee and will only have to pay income tax. Roth IRAs can be used to help multiple students as they typically do not have a designated recipient.

Life insurance

When discussing life insurance, you probably think of the death benefit, but some policies offer valuable living benefits as well. Some policies offer benefits that can be used for other uses—like higher education. A permanent life insurance policy that can accumulate cash value, like indexed universal life insurance, can offer tax-deferred growth¹ and policy loan options.² You can access potential cash value through policy loans, which are generally income tax-free. Plus, benefits do not affect financial aid eligibility and the money can be used for additional expenses beyond tuition and books, like transportation or travel costs, sports or club activity fees, a computer, or sorority and fraternity fees. Learn more about the role of life insurance in college planning and how a policy can help with tuition costs.

Conclusion

If college planning is underway or you’re looking for a place to get started, reaching out to a financial professional can be a great next step. Together you can discuss your goals, review all possible savings options, and determine how to help make your child or grandchild’s academic dreams come true. By starting to save as soon as possible, even when your children are very young, your money can have a greater opportunity to grow and help them be better prepared once they’re ready to head to campus.

1. The tax-deferred feature of the universal life policy is not necessarily for a tax-qualified plan. In such instances, you should consider whether other features, such as the death benefit and optional riders make the policy appropriate for your needs. Before purchasing this policy you should obtain competent tax advice both as to the tax treatment of the policy and the suitability of the product.

2. Policy loans from life insurance policies generally are not subject to income tax, provided the contract is not a Modified Endowment Contract (MEC), as defined by Section 7702A of the Internal Revenue Code. A policy loan or withdrawal from a life insurance policy that is a MEC is taxable upon receipt to the extent the cash value of the contract exceeds the premium paid. Distributions from MECs are subject to federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax before age 59½, with certain exceptions. Policy loans and withdrawals will reduce the cash value and death benefit. Policy loans are subject to interest charges. Consult with and rely on your tax advisor or attorney for your specific situation.

The primary purpose of life insurance is to provide a death benefit to beneficiaries. Because of the uncertainty surrounding all funding options except savings, it is critical to make personal savings the cornerstone of your college funding program. However, even a well-conceived savings plan can be vulnerable. Should you die prematurely, your savings plan could come to an abrupt end. To protect against this unexpected event, life insurance may be the only vehicle that can help assure the completion of a funding plan. In addition to the financial protection aspect of insurance, the tax-deferred buildup of cash values can be part of your college savings plan. Generally, if the policy is not a Modified Endowment Contract then tax-free withdrawals can be made up to the contract's cost basis. Moreover, if the policy is not a Modified Endowment Contract, then loans over the cost basis are also tax-free as long as the policy remains in force.

The term financial professional is not intended to imply engagement in an advisory business in which compensation is not related to sales. Financial professionals that are insurance licensed will be paid a commission on the sale of an insurance product.

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