With tuition fees consistently rising, it is becoming increasingly difficult for young people to get a college education. While there are college grants and scholarships, the level of competition for these places is insane; getting a student loan is also not an easy job.
The Spiralling Cost of Tuition
According to the College Board Report, students doing a four-year course at a private college can expect to pay (in tuition fees, boarding, and lodging) about $38,589 in the year 2011-2012. On the other hand, students at a public institute paid about $17,000 for the same course.
College fees are rising even faster than inflation. In the last five years, it has been noted that tuition fees have risen 5.6% while inflation just 3%. There is no way to exactly predict the increase in cost but it is estimated that the cost of private education will be $200,000 by the year 2016.
#1 Option – a 529 College Savings Plan
If as a parent you want to save at least a part of the funds for your child’s education, the best place to start is the 529 college savings plan. This plan is popular as it helps you save on taxes as well. As longs as the money are used for education-related purposes such as tuition fees, boarding, lodging, etc you need not pay taxes when the amount is withdrawn.
Investing in a 529
The 529 should be created as a custodial account. It should be in your name with your child as your beneficiary. Begin by determining the dollar amount required for the college education of your child and invest accordingly. You can make use of the online college fee calculators to help figure out the amount you need to save. As the amount saved in 529 is exclusively for college education it is very important to get the numbers right as you do not want to risk over-saving.
But what happens if you do over-invest? If the money is withdrawn for a non-college expense then, a 10% penalty is imposed on top of the regular income tax on the earnings. The beneficiary can be changed to another child though to prevent incurring the penalty. The best strategy to avoid a shortfall of funds or investing excess funds is by using other investment plans that can be used for college expenses as well.
Other Investment Ideas
Apart from 529s, many other investment plans will help you save effectively and could offer many ancillary benefits as well.
1. Roth IRAs
Roth IRAs are retirement accounts that are similar to traditional IRA but here you can withdraw contributions made for any purpose without any penalty being imposed.
Earnings can also be withdrawn without incurring the 10% early withdrawal penalty but only if it is used for educational purposes. Tax will be imposed on those earnings if the withdrawal is more than the total contributions, however.
2. Permanent Life Insurance
Permanent life insurance is a plan where there is an insurance component and a cash component that can be withdrawn or borrowed. The additional perk is that the cash value of the life insurance policy is not considered as a liquid asset when the college determines the financial aid that your child is qualified to get.
When the money is borrowed against the cash value, tax needs not to be paid. But, interest on the loan has to be paid. You can borrow against the investment component to get a portion of the investment tax-free; but, if you make a withdrawal you will have to pay taxes on your earnings.
Permanent life insurance policies are complicated hence the various available options need to be reviewed carefully. It is better not to invest in life insurance as a saving component unless you need to do so.
Permanent life insurance is also not a liquid investment. They usually have a particular time period in which they have to be paid or else one would have to pay a penalty. The ramifications of borrowing and withdrawing from the life insurance before taking out money from it to pay for the college should be understood before investing.
3. Fixed Annuities
Fixed annuities are those from which you can withdraw during retirement or receive a fixed income. Fixed annuities will not count against you when being assessed by colleges for financial aid as they are classed as retirement savings. The downside is that the IRS charges a heavy penalty for early withdrawals. You will also likely incur a penalty for tapping into the fund during the initial surrender period.
However, if you are more than 59.5 years old when your child is attending college, the annuity can be a great choice as it is long out of the surrender time by the time you tap it. But, if you are not 59 years old then the annuity is likely a very poor savings instrument for any other purpose than your retirement.
Leave a Reply