Research has shown that young children understand both the value of money and that going to college takes money. Even though most families are unable to save enough to pay for the entire cost of college, the presence of any amount of savings can increase both parents' and children's aspirations about the likelihood of college attendance. College costs are increasing about twice as fast as inflation, so we need to ensure that we are prepared for those costs. Unfortunately, the cost of getting an education from Harvard, Princeton, Berkley, and others is rising so it is probable that by the time your child attends college, the cost of attending such institutions could be nearly a $130,000 per year. What are you doing to prepare? So, what are the types of college savings options? There are traditional savings accounts, savings bonds, IRAs, Coverdell Educational Savings Accounts (ESA), and 529 plans.
Traditional Savings Accounts
People typically think of traditional savings accounts to save for college. While these accounts are quite safe, they tend to have very low rates of return - currently, Savings Accounts are yielding approximately 0.20% APY (Source: Bank of America, Growth Money Market Savings Account)
U.S. Savings Bond
- Savings bonds are a reliable, low-risk option backed by the U.S. government. They can be used for a variety of purposes, including paying for educational expenses and supplementing retirement income. Bonds may be purchased electronically or as paper bond certificates.
- The maximum amount of savings bonds that can be purchased in a year is $5,000. The maturation period for bonds-the length of time it takes for a bond to reach its full value-is 20 years. A savings bond has an interest-bearing life of 30 years. Because it takes so long for a bond to mature, you should use them as a college-saving mechanism if you start saving for education very early. If you redeem EE Series Bond within the first five years, you will lose the interest earned in the previous three months. There is no interest penalty if you hold a bond for at least five years. To own a U.S. savings bond, you must have a Social Security Number.
- Current Rate: EE Series Bonds issued between Nov 2011 - Apr 2012 earn a fixed rate of interest of 0.60%. Interest earned on your Series EE Bonds is exempt from state and local income taxes
- Tax Advantages: You can defer federal income tax until you redeem the bonds, or they stop earning interest after 30 years. Special tax benefits are available for education savings. If you qualify, you can exclude all or part of the interest earned on EE Bonds from income when the bonds are redeemed to pay for post-secondary tuition and fees.
- Traditional & Roth - these are really structured for use as a source for retirement income
- Annual contribution cap, typically at $5,000 if you are younger than 50. The LOW cap makes it difficult to accumulate funds to pay for college, especially if you don't start when the child is young.
- Tax Advantages - Traditional IRA: You may deduct the value of your annual contribution from your income when you prepare your tax return.
- Penalty: No 10% penalty for early withdrawal if the funds are used to pay for Qualified Higher Education Expenses (e.g. tution, fees, books, supplies, room & board)
Coverdell Educational Savings Accounts
- The total contributions for a beneficiary of a Coverdell account cannot exceed $2,000 per year, regardless of the number of accounts that have been set up. The LOW cap makes it difficult to accumulate funds to pay for college, especially if you don't start when the child is young.
- A beneficiary is an individual who is under the age of 18 or a special needs beneficiary.
- You make contributions to a Coverdell ESA with after-tax dollars-the contributions are not deductible. However, funds in an account grow tax free until withdrawn.
- It is also important to note that the beneficiary is the owner of a Coverdell ESA. As a result, the value of the account could affect a student's eligibility for financial aid.
- Unless Congress acts, certain ESA benefits expire after 2012. The annual contribution limit will be reduced to $500 making this option effectively useless.
529 Savings Plans
- Specifically designed to save and pay for education expenses.
- 529 programs are generally administered by each State and D.C. Only Wyoming does not have a 529 Plan.
- Two types only.
- Age-Based gradually shift from a concentration in stocks to a concentration in less risky fixed income securities as your child approaches college age
- Static maintain a constant blend of equities and fixed income securities which do not change as your child approaches college age
- principal-protection account that earns a specified level of interest
- **The most popular investment option is an age-based fund. The idea is to have a more conservative portfolio as the time to use the funds approaches. This approach is similar to the strategy used for target-retirement date funds.
- Calculator: http://www.finaid.org/calculators/costprojector.phtml
- EFC Formula Guide 2014-2015 http://ifap.ed.gov/efcformulaguide/attachments/091913EFCFormulaGuide1415.pdf
- Programs that allow residents to attend university in another state, without having to pay out-of-state tuition: http://www.nasfaa.org/students/State___Regional_College_Tuition_Discounts.aspx
- Vanguard 529 plan