A College Education Can Cost A Small Fortune

Recent studies indicate that, on average, a private college can cost about $20,000 a year. That number drops to about $10,000 for a public college. That's about $40,000 - $80,000 for a four-year education. These figures, which reflect costs today, don't take into account that college tuition and fees increase annually at a rate greater than general inflation. According to the Department of Labor, college tuition and fees increased an average of 8.7% annually from 1978 to 1997, while the general average annual inflation rate for the same period was 4.9%. If you want to pay for college, it's in your best interest to start saving now.

Where Do You Start?

Thinking about college as a long-term investment rather than as a short-term expense can greatly enhance your ability to save the money you'll need to afford your first-choice school. Saving early means you'll invest less money to meet the same goal than if you wait until a couple of years before your child starts college. Saving early also means that you can afford to be more aggressive in your investing strategy because long-term investing typically withstands higher risk and potentially higher returns.
The first step to creating a savings plan for college is to determine how much you'll need. Questions to consider include:

• Will your child go to a private or a public college?
• How much time do you have to save?
• How much can you afford to save each month?
• What types of financial aid will be available?

Investment Strategies

The type of investments you choose will depend on how you answered the questions above. For example, you'll need to save more money if your child plans on attending a private college instead of a public one. You'll benefit from an aggressive investment strategy if your child is still young, until age 5 or so. Investing in the stock market is a good option for you because, historically, it has a 10% - 12% rate of return. This means that a $1,200 investment each year will grow to $60,191 in 18 years with a 10% rate of return. If you start investing as your child gets older, you'll want to be less aggressive the closer you get to the first day of school. It's a good idea to talk with a financial professional who can recommend an appropriate mix of investments, such as stocks, bonds, and mutual funds.

Tax-Deferred Investments

There are financial investments that allow you to fund your child's education and receive tax breaks at the same time. You may consider one or more of the following:

• Traditional IRAs
  • Disbursements aren't subject to the 10% withdrawal penalty typical for other withdrawals.
  • Tax-deferred earnings are eliminated if the funds are used for education expenses.
• Education IRAs (EIRAs)
  • Contributions can only be up to $500 per year for children under age 18.
  • The funds aren't taxed until they're distributed.
• Roth IRAs(EIRAs)
  • Funds may be withdrawn penalty free to fund education expenses.
• Savings bonds
  • You can cash in savings bonds and declare them tax exempt if the amount you cash in doesn't exceed the qualified education expenses.

Interest earned on these investments can only be used for qualified education expenses, such as tuition, housing, and books. These tax incentives all have certain requirements and restrictions, such as income level, so it's important to discuss them with a financial professional who can help you determine what's right for your situation.

Qualified Savings Tuition Plans

Another way to save for college that offers tax incentives is state tuition plans. Money from either one of these plans is typically exempt from state taxes. Federal taxes at your child's tax rate are deferred until the money is withdrawn. You can't contribute to these plans and to an EIRA in the same tax year.
State Education Savings Plan
- More than half of all states offer this savings plan, and you can invest in any one without regard to residency. You can use the money for any public or private college in any state.
There are drawbacks to these plans, including:

• Your rate of return isn't guaranteed.
• You can't control how your money is invested.
• You won't qualify for state tax exemptions if your child attends a school in a different state.

Prepaid Tuition Plan
- With this investment option, you pay for future college expenses at current rates. Payments can be made monthly or annually. Not all states offer this plan, but the number is increasing each year, and each state has its own requirements. This is primarily for public colleges; however, private colleges are looking into offering this payment plan. Most states guarantee tuition for schools within that state.
Drawbacks to this plan include:

• Your child's financial aid eligibility is greatly reduced.
• Most states will only pay the amount for in-state public college tuition if your child decides to go to an out-of-state or a private college.
• You may only receive a partial refund if your child decides not to go to college.
• Once your children are in college, you can take advantage of the 1997 Taxpayer Relief Act, which introduced two new tax credits to help with the cost of paying for college:

• Hope Scholarship credit - You can deduct up to $1,500 for the first two years your child is in college.
• Lifetime Learning tax credit - You can deduct 20% of the first $5,000 of qualified education expenses.

These tax credits can't be used if withdrawals are also made from an EIRA in the same tax year. You can also deduct up to $2,000 per year in student loan interest payments.

Thinking about paying for your child's college education doesn't have to be horrible if you're prepared. Selecting appropriate investment strategies is the first step to being in control of the situation.

February 06, 2019