Resources

Get Educated: Saving for College

Most parents want to help their children with a college education. You may have already considered the bewildering array of savings strategies and vehicles, or you may expect your child to use scholarships, grants and loans. While many students will qualify for assistance, most of those who receive scholarships and grants find they don’t cover the full cost of an education. Students who rely on loans can find themselves with a heavy debt burden at graduation, which can take many years to repay. We think it’s wise to explore all your options: fill out the FAFSA (Free Application for Federal Student Aid), apply for private scholarships and grants, and accumulate savings for college expenses. It’s wise to start early, and to educate yourself about the many tax-advantaged programs available to you. Here are some strategies:

Qualified Tuition plans or “529 Plans”

Qualified Tuition plans, commonly known as 529 Plans, are tax-advantaged plans designed to save for future education costs. They are sponsored by states or eligible educational institutions, and are authorized by section 529 of the Internal Revenue Code. There are two types: Prepaid Tuition Plans and Education Savings plans.

Prepaid Tuition plans are generally sponsored by state governments and have residency requirements. Some are guaranteed by state governments, but not all, so it is possible to lose money if the sponsor has a shortfall, or if your student does not wish to go to a participating university. As the name implies, the plan covers future tuition, but usually not room and board.

Education Savings Plans are more flexible and more popular than prepaid tuition. Savings accumulate tax-deferred and can be withdrawn tax-free as long as they are used for qualified higher education expenses, which include tuition, mandatory fees, room and board, books and supplies. You can include computers, internet service and software if these are necessary to the educational purpose. Funds can be used at any accredited college or university, sometimes including overseas. This type of plan can also be used to pay up to $10,000 per year for tuition at any public, private or religious elementary or secondary school. The Educational Savings Plan represents the most practical and versatile option for many families. Beneficiaries can be changed to a sibling, parent, or cousin if the first beneficiary does not exhaust all the funds during their college career.

Education savings plans are sponsored by state governments. Plans vary by sponsor and differ in their investment offerings. It is very common to offer a variety of mutual fund portfolios, and many states have an "age-based" portfolio that will automatically adjust your student’s investments to align with their age. That is, if you begin an account for a newborn, it will hold more equity investments, since the child has a long time horizon and it’s reasonable to take more risk at that point. As the student approaches college age, the portfolio will automatically shift toward bonds and cash equivalents, in order to minimize volatility as you prepare for the distribution phase of the investment. Fees vary by plan, so it is important to shop and find a plan that suits your needs. There are generally no restrictions on which state’s plan you use, but you should be aware that some states offer a tax deduction for contributions to their own plan. California does not offer this deduction, so there is no disincentive to a California resident to using other states’ plans. You can compare plans on some of the websites listed below.

Coverdell Educational Savings Account (ESA)

Coverdell ESA’s offer a wide variety of investment alternatives and tax-free growth, similar to a 529 plan. Qualified education expenses include college costs as well as private elementary, middle, high school, or preschool tuition. However, the annual contribution limit of $2,000 is quite low, and makes it difficult to save enough. Also, the ability to donate is limited by income. Eligibility is phased out when Adjusted Gross Income (AGI) reaches $95,000-110,000 for singles and $190,000-220,000 for couples.at higher incomes.

Custodial Accounts

Custodial or UTMA (Uniform Transfer to Minors) accounts are established in the child’s name, with a parent or other adult as custodian. Unlike the tax-advantaged plans, there is more flexibility for contributions and withdrawals. Contributions need not be in cash, so if you wanted to fund a child’s education with a gift of assets such as stocks or bonds, this might be the best option. The child gains control of the account on reaching majority age, and can spend it as they like. There is no way for the donor to control whether it is spent on education at that point.

Coordinate your Resources

In pursuing your college savings goals, you will have more options available if you start early and invest regularly. You should also consider how your savings will affect your child’s eligibility for financial aid, including the way you title the assets. For example, the federal student aid application develops an "Expected Family Contribution" that includes a percentage of the parents’ assets and a higher percentage of the students’ assets. 529 assets will be counted if held by the parents, but not if held by grandparents. However, if the grandparents are owners of the 529 plan, the distributions from the plan will count as income, and that will affect the student’s eligibility. You can learn about the Expected Family Contribution on the websites below. It’s a good idea to familiarize yourself with FAFSA rules well before you fill out the application. Encourage your student to start early in applying for financial aid, as many scholarship deadlines are in the fall of senior year. Visit the college of their choice, and stop by the financial aid office. Use the sites below to search for scholarships your student might qualify for. While Federal grants are need-based, private scholarships often aren’t, and can be available to students based on their major, their extracurricular activities, ethnicity etc. Avoid paying for a scholarship search service. With the tools below and a decent essay, your student has a good chance of being awarded some funds for education.

For Further Exploration:

• College Savings Plan Network
• Learn about 529 plans, tax incentives, financial aid
• The federal site, a great place to earn about FAFSA
• Scholarships and other sources of financial aid
• Search for scholarships

The opinions voiced in this material are for general information only, and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. This information is not intended to be a substitute for specific individualized tax advice. We suggest you discuss your specific tax issues with a qualified tax advisor.