Saving for College

Where to Start

Decide whether Zero Coupon Bonds, EE Bonds, 529 Plans, or a combination of these savings options is right for your family.

Ah, college. Those young, carefree years with nothing to do but study and party. While that may be your child’s perspective, as a parent, college has a whole different meaning to you.

College is an expense. A worthwhile expense, but a significant expense nonetheless.

There are several ways to approach paying for college. Your child can apply for as many scholarships as possible, work her way through school, and/or take out student loans. Your best bet, however, is to reach the college years with savings that has been specifically earmarked for your child’s education. And while you may end up with a combination of loans, scholarships, jobs and savings, putting money away takes the most planning upfront and should be planned for long before your child graduates (or even enters) high school.

Saving for college is very much the same as saving for retirement, a home, or any large purchase. You need to set a goal (how much will college cost by the time your child is ready?) and a deadline (when will that time come?). Next, you’ll choose your savings vehicles. Since college expenses are an almost universal issue, there are programs for savings that have tax benefits and/or make it easier to save. Consider the following:

EE Bonds. These bonds are sold for half of their face value and are backed by the United States government. On the tax side, there are no local or state taxes to pay and even the federal tax is deferred until the bond matures or is redeemed. If the bond is redeemed in the year you pay the college tuition, there are no taxes at all. Plus, if you buy a bond after 1989, there will never be any federal taxes for income-qualifying parents.

Zero Coupon Bonds, another option, gives you zero interest until maturity. These are among the safest investments, as they are issued by the US Treasury. However, you’re still paying taxes on it, unless you buy a tax-free bond. The prices swing with changes in interest rate, so this should only be used for a long-term investment. If you might need the money before your child goes off to college, zero coupon bonds are not a good idea.

529 Plans. This is your best option, but you don’t want to overdo it. If you end up with more money in a 529 plan than it takes to pay for qualified college expenses, you’ll lose the tax benefits.

There are two types of 529 plans. One is prepaid tuition. The other is a higher education savings account plan. When you save in a 529 plan, your savings are tax-deferred. Use the funds for qualifying expenses, such as books, fees, room and board and, of course, tuition, and you’ll avoid taxes completely. When withdrawing funds from the plan, be sure to withdraw just enough money to cover the qualified costs mentioned above. Anything above that will be taxed. Keep in mind that you’ll need to subtract any scholarships or other tax-free assistance your child receives, as well as expenses you've counted toward an education tax credit before figuring what you can safely withdraw from the account.

If, for whatever reason, the money in a 529 plan is later used for a non-education expense, you’ll be required to pay income tax in addition to a 10% penalty on the earnings. A household does not have to income-qualify to participate in 529 plans, so whatever your income, you can save for college this way.

Grandparents can get involved too, by contributing up to $12,000 a year for each child, or $24,000 per year per child when grandma and grandpa contribute together, without having to worry about the federal gift tax. Or they can contribute $60,000 ($120,000 if it’s a joint gift) into the account at one time and then average the gift over five years. And, the money can later be switched from one grandchild to another.

Concerned that saving that much will lower your chances for getting financial aid? Don’t be. As a parent-owned account, 529 plans are assessed at 5.6% compared to a 20% assessment on student savings. Grandparent owned accounts are not taken into account at all.
You can open a 529 plan in any state, not only the one you live in. However, although there is no federal tax deduction for contributing to a 529, your state may offer a tax deduction. Click here for a listing of state plans. Once a year, you can switch plans.

It’s easy to see why 529 plans are becoming so popular. Between the tax advantages and their availability, it’s an excellent choice for saving for college.

If your child is of college age now and you haven’t saved much, it’s not too late to help out. Assist your child in applying for scholarships wherever possible (research the various available scholarships online) and have an open discussion on what you can (and can’t) give her monthly. There’s something to be said for a young adult paying for at least part of his education and balancing a job with a full-time college schedule.

By all means, save as much as you can. Apply for as many scholarships as possible. But when it comes down to it, if your child has to borrow and/or work to pay for part of her college expenses, it’s a lesson in responsibility and your child will appreciate the education all the more for it.