If you have kids headed to college, the annual costs may give you serious sticker shock. Consider these projections from The College Board's 2015 Annual Survey of Colleges. For the 2015-16 academic year, the average annual cost for tuition, fees, and room and board at a private four-year college averaged $43,921. For public institutions, the price tag was $19,548 — assuming you're an in-state resident.
If you are just starting to think about an education fund because your kids are still quite young, it may be hard to predict exactly how high those costs may be when they actually enter college. For the past decade, college prices have risen at least 10 percent every five years.
"As with everything, the sooner you can start planning and saving for college costs, the better," advises Kelli A. Hill, CFP®, Regional Wealth Planning Manager for the Great Lakes Region at Wells Fargo Private Bank. However, even if you've set aside what you think will be more than enough for an education, Hill says there are many strategies and financial tools that you can leverage to lessen the financial burden of paying for college. And if you don't think you'll be eligible for need-based financial aid, you may want to explore financial options that accomplish two things:
- Help take full advantage of your savings/investments.
- Employ tax-efficient tactics so you can put more of your money to work for you.
Here's a breakdown of the most common — and effective — ways to efficiently finance a college education:
1. Apply for merit-based and institutional aid
Your family doesn't necessarily need to prove financial need for your kids to be eligible for scholarships or other merit-based awards and institutional aid. Research different types of scholarships or institutional aid available, many of which you can apply for online and are valid at any college. To boost the chances of receiving a merit-based award from a specific school, ask your child to consider applying to a few colleges where their academic achievements in high school would be likely to land them in the top quartile of applicants. Your children may qualify based on a combination of their high school grades, ACT/SAT test scores, extracurricular activities (leadership roles, volunteerism, etc.), or special skills (music, acting, etc.). Hill says colleges may also give outright grants to students who have a specific background or talent they find desirable.
2. Consider federal student loans
High-net-worth families aren't likely to qualify for need-based federal financial aid, but that doesn't mean borrowing isn't a viable option. Your child may qualify for unsubsidized federal student loans. These loans typically carry low interest rates and feature long payback periods. Filing a copy of the Free Application for Federal Student Aid (FAFSA) provides the school with the information necessary to determine a package of (need-based and non-need-based) financial aid for your child. "Even if you can afford to pay the entire cost of your child's college, having your kids take out a small amount of loans can be one way for them to 'have some skin in the game,' by taking on some of the financial responsibility for college themselves," notes Hill.
3. Review alternate borrowing options
Some families opt to take out private student loans or tap a home equity loan or line of credit (which may offer a tax deduction — talk to your tax advisor to see how it may affect you) to pay for college. Whether you choose to borrow rather than pay for tuition from personal savings may depend on your particular financial situation and whether you feel you can earn a higher rate of return on your money by investing it rather than putting it immediately into tuition payments, notes Hill.
4. Create a 529 College Savings Plan
If you still have a little time before your kids enter college, a 529 College Savings Plan (529 Plan) is a widely used investment option to consider, says Hill. "It works a lot like a 401(k) or Individual Retirement Account (IRA)," she explains. Money you contribute to one of these plans (with your child as the beneficiary) grows tax-free. And, as long as you use any withdrawals to pay for qualified secondary-education expenses for the beneficiary, the accounts' earnings are also tax-free.
Every state offers its own 529 Plan, and you aren't limited to your home state's plan. Some states offer upfront state tax deductions for residents' contributions, however, so do your research to make a wise choice. "It's smart to look at the track record of different states' 529 Plans and choose one that offers a range of investments you like, charges low fees, and posts competitive returns," suggests Hill.
"It's smart to look at the track record of different states' 529 Plans and choose one that offers a range of investments you like, charges low fees, and posts competitive returns." — Kelli A. Hill, CFP®, Regional Wealth Planning Manager, Great Lakes Region, Wells Fargo Private Bank
Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 Plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest.
- 529 Plans are subject to enrollment, maintenance, administrative and management fees and expenses.
- Non-qualified withdrawals are subject to federal and state income tax and a 10 percent penalty.
- College savings plans offered by each state differ significantly in features and benefits. The optimal plan for each investor depends on his or her individual objectives and circumstances. In comparing plans, each investor should consider each plan's investment options, fees and state tax implication.
One more important thing to remember: You could be subject to taxes and fees if you don't use all of the 529 savings for college, or your child doesn't attend college at all. "Be sure to talk with your advisors at The Private Bank to understand restrictions and review potential options, such as transferring the money to another child or family member," Hill says. "Before you make any decision, get informed on the various outcomes so that you can take the path that is right for you and your family."
5. Explore other options
Depending on your unique circumstances, you may be able to find other effective savings paths. If you own a business, you could hire your child and contribute an amount equal to their annual earned income to a Roth IRA held in your child's name. Contributions to that Roth may grow tax-free and could later be withdrawn for college. Earnings could remain in the account for your child's eventual retirement.
If your child receives financial gifts from grandparents or other family members that you'd like to earmark for college, you could also talk to your relationship team about whether it would make sense to create an annual gift trust, minor's trust, Uniform Transfer to Minors Act (UTMA) account, or even a Family Limited Partnership (FLP) or Limited Liability Company (LLC).
More tips to boost your savings
Overall, reducing taxes on your investments to make more of your money available for college expenses is a key part of college-payment planning, notes Hill. However, tax deductions should never be your only consideration.
"In some cases, you may find that you can earn a higher after-tax return on your investments in a taxable account rather than a tax-advantaged account like a 529," notes Hill. "The bottom line is that there are many different ways to finance your child's college education. Your relationship team can help you sort through the options that best meet your needs."