College is expensive, and the costs of attendance generally continue to rise at a significant rate. Many people want to at least help their children through college financially, if not pay for it for them completely. But should you?
Before you ever consider paying for your child’s college education, you need to first make sure that you’re taking care of your own financial situation. This is sometimes an unpopular opinion among parents, but one that’s very popular among financial planners. I get it, they’re your pride and joy and you want what’s best for them. But sometimes you have to think about yourself first.
We all know about how student loans are affecting the finances of younger generations, but there will be resources (yes, including student loans) available to your children to help them pay for college. On the other hand, if you’re forced to quit working due to a disability or health problem, or you reach the age that you’d like to retire, there’s not much that you can do if you spent the money that you need to retire on putting your children through college.
Placing paying for your child’s college education above your own financial situation could lead to you not reaching your own goals and having to sacrifice later in life, or potentially even work longer than desired.
I don’t think that everyone needs to (or should) go to college, but I’m sure a lot of people will still attend college in the future and many jobs will require it. What if you save a hefty amount for your child’s college education and they don’t go to college, though? What if they receive a scholarship? Where should you save for college (if you’ve already made sure that you’re taking care of your future self) anyways?
If you’ve taken care of yourself, and you have the capacity to do so, here are 4 options to save for college education:
529 Savings Plan
A 529 plan is a tax-advantaged education savings plan in which you can invest money. Investments within a 529 grow tax-deferred and the money can be pulled out tax-free, if used for qualified education expenses. The money that you save within a 529 can be used for qualified education expenses at colleges and universities, vocational and technical schools, and even primary and secondary education, as of 2018. (Note: Refer to the rules of the 529 plan that you use for specific guidance on what is considered a qualified education expense and what institutions qualify).
In Indiana, contributing up to $5,000 to a 529 plan will provide you with a 20% state tax credit, up to a maximum credit of $1,000 ($5,000 x 20%). That’s a pretty good incentive, but what if you save into the account and your child doesn’t go to college? You can change the beneficiary of the account to another eligible family member, pull out the money and pay the taxes due plus a 10% penalty, or wait and save it for later. If your child receives a scholarship, then you can pull out funds up to the amount of the scholarship penalty free, but you’ll still be responsible for paying the taxes on the earnings.
529 plan contribution limits are very high (up to $450,000 per beneficiary in Indiana) and vary by state. However, a contribution over $15,000 in 2018 ($30,000 for married couples) could cause gift tax consequences. Still, you’re able to make a lump-sum contribution of 5 years’ worth of contributions ($150,000 for married couples) in one year and avoid any potential gift tax consequences.
Roth IRA
If you don’t want to have to worry about your child not going to college and how you would deal with the money in a 529, then you could use a Roth IRA as a pseudo college savings account. However, there are a few potential limitations to using a Roth in this manner.
First, you would end up pulling money from a retirement savings account with great tax advantages that you may want to keep for retirement. Secondly, those under age 50 can only contribute $5,500 to a Roth IRA in 2018 ($6,000 in 2019). Those over age 50 have an additional catch-up contribution of $1,000 for a total contribution of $6,500 in 2018 and $7,000 in 2019. You must have earned income of these amounts to be eligible to contribute them to the account.
Additionally, there are income phase-out limits to contributing to a Roth. In 2019, those who earn $193,000 or less and file their taxes as married filing jointly ($122,000 for those who file as single) can contribute up to the limit. However, those who earn more than $193,000 ($122,000 for single) begin to be phased out of making contributions and those who earn $203,000 ($137,000 for single) or more are not eligible to contribute to a Roth.
The positive side of contributing potential college savings to a Roth is that you can pull out contributions (not earnings) from a Roth IRA to pay for qualified college education expenses without penalty or being taxed, if you’re under age 59 ½. If you’re over age 59 ½, and have had a Roth open for 5 years, then you can pull out contributions and earnings tax and penalty free. If your child doesn’t go to college, then you just keep the money in the account for your retirement or to pass on to your heirs.
Taxable Account
You could simply save into a checking or savings account for your child’s college education. However, you run the risk of your money losing purchasing power to inflation. Alternatively, you could open a brokerage account and choose an investment allocation for the money. This would be similar to saving to a Roth in that you could keep the money in the account and use it for retirement if your child does not attend college. However, if they do attend college, then you would be taxed on any gains that you recognize when selling securities to raise cash to pay for college education expenses.
Cash Flow
If you have, or believe that you will have, a significant enough income that will allow you to continue to save, reach your goals, and also pay for your child’s college education, then you may be able to cash flow the expense once the time comes.
There are multiple strategies for saving for college education expenses, including combining those strategies mentioned above, but there isn’t a one size fits all approach. One thing that is very important to keep in mind is that you need to take care of yourself before worrying about paying for your child’s college educations.
Avenues will be available for them to pay for college, but you can’t go back and press redo on saving for retirement.
