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Paying for College: A Parent's Guide

May 17, 2019 · 8 minute read

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Paying for College: A Parent's Guide

When you hold your child in your arms for the first time, adulthood seems so far off. But the years will speed by, and before you know it, they’ll be heading to a college campus and beyond. Just the idea of finding ways to pay for your child’s education and determining how much it will cost can make your head spin.

Fear not. Parents can—and do—successfully find ways to pay for college within their budgets, but often with a bit of necessary sacrifice. This guide will help parents paying for college determine the costs, decide how much they can save, and create a savings strategy.

How do parents save for college? Early and consistently. Those are two crucial elements to creating and sustaining a plan to meet your child’s college education costs. By starting as soon as possible, you’ll have more time to potentially help your hard-earned savings grow.

And by making consistent deposits into whatever vehicle you choose, it can help smooth out the ups and downs of the stock market. Consistently making equal payments also makes the task of saving easier over time.

There are also strategies to help you pay for college during and after the university years. A brief note before we get started: there’s no one “right” strategy to pay for your child’s education. The tips we’re offering here are purely informational, don’t take into account your specific circumstances, and aren’t intended to be investment or financial advice. We always recommend you chat with a licensed professional before making financial decisions about funding your child’s college education.

Now, let’s start planning so you can start saving right away.

How Much Will I Need to Save?

Parents paying for college tuition and other costs usually understand that education expenses have risen quite a bit over the past two decades—and they’re highly likely to continue to rise in the future .

So, let’s talk about what you might need to save for future college costs. Of course, there’s no way to definitively say how much college will cost in years to come. But in the last 10 years, we do know that tuition and fees at public four-year colleges have gone up 3.1% beyond the rate of inflation.

And private four-year colleges have seen a 2.3% increase (beyond inflation) from the 2008 to 2009 school year to the 2018 to 2019 school year. These increases are actually less steep than the increases observed from the two decades prior. (From 1998 to 2008, public college tuition went up 4.2% beyond inflation—so things actually are getting better.)

Though college tuition increases aren’t quite as hefty as they once were, if we’re destined to see annual 3.1% increases over the next 10 years, it’s safe to say college isn’t going to be cheap. But there’s still good news: You might not end up paying sticker price for your child’s college education. There are a myriad of scholarships and grants your child could potentially qualify for.

As college tuition increases, so do some grant allowances—though admittedly, the grants may not be increasing as fast. (In the last 10 years, public four-year colleges have gone up 3.1% in price, but the Pell Grant maximum has only increased by 1.2% in the same period of time.)

How Much Should I Contribute?

Once you have a reasonable target, you need to decide how much you can contribute. Ask yourself whether you want to pay for the entire cost or just a portion. Can you pay some here and there? Should you consider borrowing in order to help your child earn their degree?

Here are some things to consider. It’s usually more cost-effective to save rather than borrow. Every dollar you borrow can cost you more than that dollar when you add interest. (Of course, how much exactly it costs you depends on the interest rate and term of the loan.)

Related: Should You or Your Child Take Out a Loan for College?

Many parents use a mix of sources to fund their children’s education. For example, you could save a third of your target, pay a third during your child’s time in college, and then borrow the last third.

It’s smart financial planning to set your house in order first, so you can save enough for college. Parents considering paying for college tuition may want to try paying off their own student loans and paying down other debts before prioritizing saving for their children’s education, if possible. Likewise, parents may want to take a hard look at their budget to see how they can trim out expenses in order to save more.

What Are Some Strategies for Saving?

How do parents pay for college, practically speaking? Now that you have a target goal in mind, you can look for ways to save for college tuition. Here are a few options to consider:

Automating savings. You could set up automatic transfers to a designated college savings account, so you won’t even have to think about it. You can transfer from your checking account or, if it’s an option, opt to direct deposit a portion of your paycheck directly to your savings account.

Putting windfalls to work. Another way to boost savings comes from the planned and unplanned windfalls in life. Getting a tax refund? Or receiving an inheritance? Keeping an eye out for unexpected money can help you achieve your savings goal.

Pruning debts and expenses. If you haven’t already trimmed your expenses, you can use the natural course of time to turn expenses into savings. For example, once your child no longer needs diapers, you can put that cost toward college savings. When they no longer need daycare, you could funnel what you were paying into your account. If piano lessons end, it’s yet another chance to increase how much you can save.

Finding scholarship matches. And once your child gets closer to high school graduation, you can help them find scholarships. FastWeb and are just two of the more popular sites that help you search for opportunities. Many allow you to set up a profile for your child that may include interests, intended majors, and even preferred schools—data points that will be used to help match your child with scholarships.

What Savings Tools Are Right for Me?

If you have your target goal and a plan to make regular contributions, you’re ready to weigh which investment vehicles will fit your needs. Here are some common savings tools.

529 Plans

The name for these plans comes from Section 529 of the Internal Revenue Code. It is a tax-advantaged account to save for higher-education costs, and it has become quite popular with parents saving for college tuition. Anyone can set one up on behalf of a beneficiary, even non-family members.

Beneficiaries can be your child, a spouse, or yourself. Contributions to 529s are made with after-tax dollars, but the growth of the investments in the account are tax-free as long as the funds are used to pay for higher education. Any withdrawals that are not used for higher education expenses may be subject to penalties and taxes.

Another caveat: If your child doesn’t go to college, the funds still need to be spent on education to avoid taxes and penalties. But the good news is that you have the ability to change the beneficiary of a 529 account to another family member.

This means that if your oldest child does not use the funds for college, you can change the beneficiary on the 529 to one of their siblings or even a family member in the next generation. Even better news, if your child receives a scholarship for college, you can withdraw the amount of the scholarship from the 529 plan penalty-free.

If you decide to withdraw it for another purpose, you’ll pay a 10% penalty plus regular income taxes. Many states offer these plans, so you’ll want to start by finding out if your state offers any tax incentives to participate in your own state’s sponsored plan.

If you discover that your state does not offer additional tax benefits for contributions, you can shop around for the lowest fees. It’s always a good idea to check with your tax advisor if you have questions about the nuances of these savings plans.

Roth IRAs

People typically think about Roth IRAs as retirement tools, but you can sometimes use them to pay for education expenses. Roth IRAs allow tax-advantaged saving for education expenses without paying penalties.

Like 529 plans, you pay taxes on the front end, and you’ll pay no taxes on disbursements, but you must have held the account for at least five years.

Only the amount you contributed to the account can be withdrawn without taxes or penalties. In other words, if you contributed $5,000 for five years, you can withdraw $25,000, tax-free, for education. They are also more flexible than 529 plans, in that if your child doesn’t use up all the contributions, you can keep the funds in the individual retirement account growing tax-free for your retirement. It’s still important to use caution when relying on your retirement account to fund your child’s education.

Roth IRAs do provide many tax advantages for long-term savings, but if you withdraw too much for your child’s education, you can compromise your own financial well-being. The IRS sets strict annual contribution limits on IRAs, so if you withdraw a significant lump sum to pay a tuition bill, you’ll likely have a difficult time replacing the money.

Coverdell Education Savings Account

A Coverdell Education Savings Account can also be used to pay for college. Contributions are made with after-tax dollars, but they grow tax-free, and withdrawals are also tax-free. Annual contribution limits are fairly small at $2,000, and the account is limited to certain incomes. Just like the Roth IRA, you can use a variety of investments to grow the account.

UGMA or UTMA Accounts

A Uniform Gifts to Minors Act or Uniform Transfers to Minors Act account can be set up on behalf of a beneficiary under 18, and there are no contribution limits. But when your child comes of age, they will be able to use the money for whatever they want, so many parents are wary of using these to plan for college.

The flip side is your child won’t be limited to just paying for education expenses and can use the money for living arrangements, transportation, or other necessary purchases. Parents should think hard about whether they can trust their child to spend the money wisely. These accounts do not provide tax-advantaged saving the way 529s and IRAs do.

401(k) Retirement Savings

If you’re a parent paying for college tuition, tapping your 401(k) can be very tempting. However, if you use funds from the account to pay for college—or any expense—you’ll pay federal taxes on the amount PLUS a 10% penalty, unless you are of a certain age. But there’s another way you can use your 401(k) for education. This is a potential strategy that you’ll definitely want to run your tax advisor.

You can borrow money from your 401(k), but there are caveats to doing so. Loans are limited to 50% of the fund’s vested amount, up to $50,000. You may have up to five years to pay off the balance, depending on your employer’s plan. But, if you leave your employer, then the balance is due right away. If you don’t pay it off on time, it will cost you the penalty and income tax.

How Can I Help My Child After Graduation?

While your students may have to take out a student loan to make it to graduation day, you can also shoulder some of the load or help them with paying back what they owe.

Parent PLUS loans can be one way to help your child afford college. They are student loans offered by the U.S. Department of Education, and parents, not students, become the borrower. You can borrow up to the amount of education expenses not covered by other aid. It’s easier to qualify if the applicant doesn’t have an “adverse credit history .”

Parent PLUS loans have a fixed interest rate with a typical term of 10 years, but that can be extended to 25 years, allowing for payment flexibility. However, unlike student loans, Parent PLUS Loans come with a fairly high origination fee —it’s currently 4.248%. Of course, in 18 years, parents paying for college may have better federal loan options.

As a parent, you can also help your student with their student loan repayment. Both private and federal student loans can be refinanced, sometimes at more attractive rates than the original federal Direct Loan. Parent PLUS Loans can also be refinanced.

If your child has established a good credit history, down the road this may allow them to pay less interest over time through refinancing. They can also potentially refinance for a new, extended term length, which can reduce the monthly payment. The downside is you lose all federal benefits including income-driven repayment and loan forgiveness when refinancing with a private lender.

But refinancing student loans can offer you and your child even more flexibility. In addition to potentially lower payments with a longer term, or lowering the interest rate, you can choose between a fixed-rate loan, where the payments are steady, or a variable-rate loan, where the rate fluctuates along with economic conditions and the market.

With a variable-rate loan, your interest rate may start lower than a fixed-rate loan, but because it can change as interest rates fluctuate over time, it has the potential to wind up with a higher interest rate.

Whether you’re just starting to plan for college, looking for more tips, or trying to help your student post-graduation, you’ll find many options to mitigate the expanding costs of higher education.

SoFi is a leader is the student loan space—offering both private student loans to help pay your way through school, or refinancing options to help you pay off your loans faster.

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