4 Important Ways That Parents Can Save for College

4 Important Ways That Parents Can Save for College

One of the most stressful financial planning challenges for parents is saving for their children’s college education. With tuition rates increasing every year, parents can expect to pay tens of thousands of dollars for public education—and many more times that for a private university. Parents may worry that they have waited too long to save, but as with everything in financial planning, it is still better to start today than a year from now. Even if parents do not save enough to cover all of tuition, every little bit helps, especially when it keeps them from borrowing more money from student loan lenders. Read on for some of the best tips for parents who want to begin saving for their children’s education.

Open a 529 College Savings Account

chequebookThe most popular method for saving for college remains the 529 college savings account. More than 12 million American families currently have an open 529 account, which lets investments grow on a tax-deferred basis. Furthermore, all distributions from the account used to pay for college expenses are exempt from federal income tax. At present, 34 states and the District of Columbia allow full or partial deductions or tax credits for contributions, and six states allow deductions for out-of-state plans. Individuals can open accounts in a different state if it benefits them economically do to so, making it imperative that people research their state’s policies. Usually, contribution limits are set rather high—typically in excess of $250,000.

Before opening the account, families should learn what qualifies as an education expense. Tuition, room and board, books, and mandatory fees all qualify as educational expenses and will not incur federal income tax.

Plans have a range of different investment options. Mutual funds are the most common option, but some accounts have guaranteed investment, CD, or ETF options. Investors can also change portfolios if they are not pleased with the performance of their initial choice.

Create a UPromise Account

UPromise is a tool that helps parents and students learn about the costs of attending college while also saving money. When parents and their children shop at participating retailers, a small percentage is deposited into a college account. Since the service does not cost any money, nor does it raise the price of purchases, it is an easy way to get a jumpstart on savings. Retailers largely participate with the program to appeal to shoppers and beat out competition. They rationalize that if families are going to spend the money anyway, they will likely spend it where they get a little something back. Parents can even ask friends and family to link their credit and debit cards to the account to maximize contributions to the account. The UPromise website also has a number of tools and valuable information about saving for educational expenses.

Look at Prepaid Tuition Plans

Many public and private colleges now offer prepaid tuition plans that allow families to lock in current tuition rates. With prices increasing significantly each year, locking in alone could save thousands of dollars. Families can usually get state plans that allow in-state residents to lock into fees for any state college or university. The Private College 529 Plan allows families to lock into rates at more than 270 private institutions that belong to the Tuition Plan Consortium. These institutions include such notable schools as Duke, Syracuse University, and the Massachusetts Institute of Technology.

Before investing in one of these plans, however, parents need to understand the caveats. State plans are typically subject to state economies so not all plans are backed by the full faith and credit of that state. Also, if the child decides to attend a private or out-of-state school, some restrictions may apply. The plan can usually be converted into a regular savings account, but parents should verify the details before signing. The Private College 529 is always convertible into a traditional 529 plan if the student chooses to attend a non-participating college.

Know How Savings Affects Financial Aid

graduatesAt virtually any institution, students will complete the Free Application for Federal Student Aid (FAFSA), which qualifies them for financial aid from both federal funds and the college’s own endowment. All families should apply even if they do not expect to qualify. The form calculates the expected family contribution (EFC), which colleges use to distribute both scholarships and need-based aid.

The EFC is based on the parent’s assets. All 529 plans owned by parents or students are considered assets and parents are expected to use 5.64 percent of assets to pay for college. Other savings vehicles, such as the Coverdell Education Savings Account, formerly called an Education IRA, are assessed at a 20-percent contribution rate.

The FAFSA does not account for 529 plans owned by grandparents nor Roth IRAs owned by parents. However, once funds from these plans are used to cover tuition, they are considered student income and factored into the EFC. Thus, contributions from these accounts should be made during the child’s senior year of high school, when there is not another FAFSA to complete.