August 6, 2015 at 5:47 PM EST - Updated July 2 at 8:05 AM
Saving for College—It's Easy When You Plan
While many people think of this time of the year as tax time, parents of prospective college students know this is also the time to start thinking about the cost of a college education.
As the cost of a college education continues to rise, it's never too early to start thinking about college financing and saving up for your child's future. Although the costs are rising, the return on investment has proven a college education is worth it. According to an article in The Economist, college graduates between 25-32 make $17,500 more annually than their colleagues with just a high school education. That's an extra $140,000 that can help them buy a bigger house or perhaps even save for their future child's education.
One way you can save is to participate in a state-sponsored savings plan. This type of plan is often known as a 529 Plan because of the IRS code that established them. These plans give students flexibility in choosing a school and provide an opportunity for parents who are running out of time to make up for it by making sizeable lump investments.
Similar to 401(k) plans, 529 plans allow individuals to invest in a predetermined pool of stock and bond investments. Most plans will require you to divide your investment according to a given asset allocation determined by your child's age. In general, the asset allocation will be more aggressive for younger children and less aggressive for children nearing college age. Lifetime contribution limits to Section 529 plans vary from state to state, but often exceed $200,000, and offer some flexibility on when you can contribute. In addition, there are no income thresholds and typically no annual contribution limits, although annual contributions of more than $14,000 ($28,000 when made jointly with a spouse) may require filing a federal gift tax form.
Once your child reaches college age, the account owner may withdraw money from the account to pay for qualified higher education expenses. Assuming that you have followed the plan's rules, there will be no penalties (nonqualified withdrawals will be subject to a 10% additional federal tax in addition to ordinary income taxes). And qualified withdrawals are tax-free. And just like retirement plans, there's no guarantee of a return on the investment. While plan managers use more conservative allocation plans, risk cannot be eliminated altogether.
Another option is prepaying for tuition. This allows you to pay for your child's future education at today's tuition prices, and you can pay for it over the course of several years. But these plans limit a child's options for attending school. Applicants will typically receive a list of participating colleges that a child can attend. However, if the student wants to attend a school that isn’t on the list, the value of the investment may be reduced.
As with any financial planning decision, the choice that is best for you and your child will depend on your family's unique situation. Here is a list of important questions you may need to consider:
What is your risk tolerance?
How many years until your child begins college?
Does your child even plan on attending college? If so, have they chosen a school?
If you have any questions, please feel free to stop by your nearby Republic Bank.
This information is not to be used as investment advice, but for informational purposes only. Republic Bank & Trust Company prohibits the dissemination, distribution or copying of this document without the Bank's prior written consent. Please consult your financial or tax advisor for further information. Member FDIC.