The total amount of student loan debt is well on its way to approaching the $1.6 trillion mark. That is trillion with a “T”. The average household with student debt owes $47,671, per a NerdWallet 2018 household debt study1. Those students who pursue professional degree programs are looking at substantially more student loan debt with numbers commonly around $200,000.
The cost of higher education has been on a meteoric rise since 1980 but there are still ways to mitigate the overall expense. There are essentially two stages when it comes to developing an overall blueprint to deal with college education costs, the planning stage and then the preparing stage. Families with young children can start planning well ahead to save money to cover the price tag of education. There is also the preparation of attending college/university when it comes to the financial aid application process. For this periodical, we will be taking a deeper dive into the planning aspect of paying for higher education.
Planning for the cost of education involves looking at different avenues in which you can save money over time. There are a few different accounts that can help accomplish this goal. Let’s take a look at a few of them:
529 college savings accounts
In general, these accounts offer special tax benefits, such as tax-free qualified distributions, when the funds are used for higher education costs. If owned by the parent or student, 529 plan distributions will also receive favorable treatment when applying for financial aid. There are two types of 529 accounts; a college savings plan and prepaid tuition plans. The college savings plans work much like a Roth IRA where you invest your after-tax contributions into mutual funds, such as target-date funds. The account value will fluctuate over time depending on your investment allocation. Prepaid tuition plans let you pay part (or all) of education costs in today’s dollars. You do not have control of how the money is invested, but you potentially lock in lower tuition rates.
Coverdell Education Savings Account
The real benefit of these accounts was the ability to also use the funds for elementary and secondary education, not just higher education. But with the relatively low annual contribution limits ($2,000 per child/year) and the recent law change allowing for distributions (up to $10k) from 529 plans to help pay for pre-college education, the Coverdell ESA is less of a viable option.
The Uniformed Transfer of a Minor Account (UTMA) is one other choice to help pay for the cost of education. The real benefit here is that the money saved into an UTMA is not restricted to just education purposes. As long as the funds are withdrawn for the benefit of the child, there are no distribution penalties. Since the account is in the name of the child, the earnings are also subject to unique tax rules – and could be favorable depending on your specific income circumstances. Although the account is technically in the name of the child, there is a custodian, usually the parent(s), who handle the management of the funds. One drawback can be that when the child reaches the age of majority, which is 21 in Washington, the money will automatically be available for them to withdraw. Knowing how some young adults are at age 21 – receiving a nice windfall of money might not be spent in the most productive ways.