How to Pay for Junior’s College (Part 1): Savings

Before I begin, there’s one important point I want to make:

The saving vehicles listed below have many restrictions and limits, which I don’t want to take up space here to go into. There are also different fees charged for these plans. I provide for my clients the service of evaluating all the different options available to them, and help them chose the perfect strategy to meet their goals. If you’d like to learn more about which vehicle would suit your specific situation I encourage you to contact me at (425) 641-5717 or amy@prismfinancialplanning.com

First, I’m going to say something that may not be PC in this “give your child the best of everything” society we appear to have evolved into, but I’m going to put it out there anyway: Have your child be responsible for paying their own way through college. Granted, college is much more expensive now than when I went to college, but that doesn't mean your child can’t contribute to the bill. Saving birthday money throughout the years instead of buying the latest video game can really add up. Part-time jobs look good on a college application and teach kids responsibility. Opening up an account that the child can see and watch grow will teach them a life lesson that will benefit them for years to come. However, given the current cost of college tuition, most likely you'll need to contribute, too. Below are saving vehicles available to you that can help grow that college fund.

Savings and Investments Options to Save for College

The most common saving vehicles for college are what are called 529 plans, which are offered by most states. You may invest in your state’s plan, or another state’s plan. There are two types of 529 plans. The first, and most common, is the 529 college savings plan. You chose mutual fund-like products to invest your money. The money available to pay for college depends on the investment’s performance throughout the years. Any income your investment earns grows tax-deferred and it will be federal (and possibly state) tax-free when you withdraw it, if the money is used to pay for college expenses. Pretty cool, huh? For those who live in high income tax states, this can be a huge benefit.

The other type of 529 plan is less common, but is what is offered in the state of Washington: the 529 prepaid tuition plan. With these, you pay for a “unit” of school. According to the Washington GET (Guaranteed Education Tuition) program FAQ’s, “one GET unit equals 1 percent of the resident undergraduate tuition and state-mandated fees at the most expensive Washington public university at the time of use.” Therefore, 100 units should buy you 1 year’s worth of tuition. When it comes time to pay for college, regardless of how much college expenses have increased over the years, that 100 units will still buy you that one year of school. Each year the cost of purchasing a unit increases.

A Coverdell Education Savings Account (ESA) is an account that can be opened in a bank or brokerage house. You invest your deposit in stocks, bonds, mutual funds, etc., and like the 529 college savings plan, any income the account earns is tax deferred and it will all be federally tax-free when you withdraw it for qualified education expenses. There is a $2,000/year limit on the amount you can deposit in the account, with a decreasing limit for those who are high income earners.

U.S. savings bonds (Series EE and I) are another saving vehicle. They can be purchased at your local bank or through Treasury Direct. You’re essentially loaning money to the U.S. Government, and in return you earn interest on the amount loaned. When you redeem your bonds you’ll receive the amount loaned plus interest earned. Interest earned is tax-free when the bond owner pays qualified higher education expenses at an eligible institution. Whatever your view of the government, this is a very safe investment, although its return will likely be the lowest.

Taxable brokerage accounts don’t have any of the tax benefits of the investments listed above, but they do offer the most flexibility. You can open your account anywhere, and invest in any product. If you have some kind of financial emergency, no one is stopping you from using these funds to address those issues (although your college-bound child will probably be a bit bummed). If the account is in your child’s name then it will be taken into account when applying for financial aid. This will also happen if the account is in your name, but to a lesser degree. Also, if it’s in your child’s name then nothing (other than good sense) can stop them from raiding the account to fund a buying spree at Bellevue Square.

Did you notice what investment is missing from my list? Retirement accounts such as IRA’s and 401(k)’s didn't make the list for a very good reason. Please repeat after me: I promise to never fund my child’s education using the money I've saved for my own retirement. I’m sure you've heard it before, but it bears repeating—your child can borrow money for school and have the rest of her life to pay off that debt, but no one will lend you money to pay for your retirement.

Come back next week for How to Pay for Junior’s College (Part 2): Loans

p.s. When I was shopping at Trader Joe's this morning it came up while speaking with the checker that I was going to go home to post to my blog about how to save for college. He said, "I just finished college without owing a penny." When I asked how he managed that he responded, "The GI Bill. They paid me to go to college!" Hmmmm...my high schooler loves playing warfare video games. Maybe I can talk him into serving his country and I can use his college fund for a cruise around the world!