It’s no secret that student loan debt is a major problem in this country. Even with recent efforts to relieve many federal borrowers of some of their debt, many individuals that are now having babies and raising children are still paying down massive student loans. As a result, parents and grandparents are thinking more proactively about saving and planning for college expenses. Here are my favorite three strategies to save for college expenses:
The 529 Plan
Quite possibly the most popular college savings plan, the 529 plan, has tax benefits without sacrificing too much liquidity. This plan comes with two "flavors". You can either invest for college savings in Mutual Funds and ETFs (529 Savings Plan) or you can purchase prepaid tuition. Contributions to 529 plans are made with after-tax dollars and earn interest tax-free as long as that interest is used on qualified education expenses. In addition, some states, such as Michigan, offer a deduction on contributions to a plan. The primary downside of 529 plans is if your child does not attend college, the account will have some liquidity restrictions. You may transfer the account to an alternative family member to be used for education expenses, but if that is not an option, you must pay a 10% penalty and taxes on the gains.
Hopefully, you are already investing in a Roth IRA already because it is a good idea for a variety of reasons (MORE ON THIS HERE). If you are not investing in a Roth IRA, this is just one more reason to consider doing so. Education expenses can be paid for from a Roth IRA penalty-free. You will need to pay taxes on the gains, but your principal can be recovered tax-free since it was funded with after-tax dollars. The main reason I like this strategy is due to the added flexibility over the 529 plan. Should your child receive a plethora of scholarships or decide the college route is not for them, you now have a nice INCOME TAX FREE retirement account.
Taxable Investment Account
Let's call this what it is: Saving and Investing. You receive no preferential tax treatment by utilizing this strategy, but that is why it has the most flexibility. With this strategy, there are no restrictions on types of investments, contribution amounts, or when and how the funds are used. We all know life happens, and sometimes that can be expensive. So, when the water heater goes out the same month your job gets relocated these funds can be utilized without worrying over IRS penalties and restrictions. The one downside to this strategy is these assets will count against you entirely when and if your child applies for financial aid. If that is not of concern to you, this may be a really good option to consider.
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Written by: Kristin Prieur