Sending a child to college is an important goal for many families, but it can be challenging as the cost of higher education continues to rise each year. On average, it costs over $35,000 per year for a student to attend college in the U.S., including tuition, books, supplies, and daily living expenses. To estimate the cost of colleges around the country, the U.S. Department of Education offers a net price calculator to help you get started. If you’ve begun exploring different ways to save for college, you may have come across several options, from 529 plans to scholarships. Let’s explore these funding options and how they can help save for a loved one’s academic future.
A 529 plan is a tax-advantaged savings plan that 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. There are two major types of 529 plans you can choose from:
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savings plan: With this most common type of 529 plan, your investment grows on a tax-deferred basis, and funds can be withdrawn tax-free to pay for expenses like tuition, textbooks, and room and board.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.
Commonly known as Federal Savings Bonds or college savings bonds, this savings option is issued by the Treasury Department and has 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.
Grants and scholarships are a type of financial aid or gift aid where students can be awarded money to help with the cost of higher education. Scholarships are typically based on merit, whether academic, athletic, or activity-based, and grants are often awarded based on a family’s financial situation. 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:
You likely think of saving for retirement when you hear Roth IRA, but they can also be used to help out with 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.
A Coverdell education savings account (Coverdell 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.
Another option you may not have considered for helping fund the cost of college is using life insurance. Some policies can go beyond the death benefit and offer benefits that can be used for other purposes—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 a computer, transportation or travel costs, sport or club activity fees, or sorority and fraternity fees. You can explore the role of life insurance in college planning in this video:
If you have already started saving for college or wish to get the ball rolling, there are many options available to help make your child or grandchild’s academic dreams become a reality. Consider meeting with a financial professional to discuss your goals and what options might be right for you. The sooner you begin saving for college, the longer your money can have the opportunity to grow—helping your child reduce student loan debt and focus on achieving this important milestone.
1. The tax-deferred feature of the indexed 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.