The average cost of tuition varies, depending on whether the school is private or public. According to the College Boards 2020 Trends in College pricing report, the average cost per student to attend college in the 2020-2021 school year was as follows:
• Private non-profit four year institutions: $37,650
• Public four year in-state: $10,560
• Public four year out-of-state: $27,020
And typically, tuition costs and room and board aren’t the only expenses college students will usually need to cover. There are textbooks and other school supplies, the cost of traveling to and from school for breaks, and any additional living expenses.
As a parent, sometimes just thinking about the cost of college for your kid (or kids) can feel bleak. Thankfully, there’s no time like a bad time to start thinking about ways to save for your child’s education.
Recommended: What is the Average Cost of College Tuition?
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How to Set up College Funds: Getting Started
Common advice is, there’s no time like the present to set up a college fund. Even starting with a small amount each paycheck could make a dent when looking at a tuition bill 10 or 18 years down the line. If you are in the early stages of parenthood, college may feel far off now, but time can fly.
When creating a strategy for setting up college funds, there are a few savings plans and investment accounts that are specifically designed to help people save for their child’s education expenses.
As you get serious about saving for your children’s education, one of these accounts may be worth considering when setting up a college fund.
529 Plans
These accounts, also known as qualified tuition plans, are named after an IRS code section and give parents the option to save for college in the name of a child while providing certain tax advantages.
There are two kinds of 529 Plans: prepaid tuition plans and education savings plans.
Prepaid tuition plans let individuals buy future credits or course units at participating colleges or universities. These credits are used to help cover the cost of tuition for the beneficiary. Most prepaid tuition plans have residency requirements and are often sponsored by state governments.
Education savings plans are investment accounts that can be used to save for the beneficiary’s qualified education expenses. The funds can be used to pay for higher education or private elementary or high schools. Money is taxed when it is contributed to the account, but it can then grow tax-free.
You can’t contribute more money than necessary to cover education expenses, and there are no annual contribution limits set by individual states. There are, however, aggregate limits to 529 plan balances, which vary depending on the state.
California has the highest aggregate limit, at $529,000, and Georgia and Mississippi have the lowest, at $235,000. While there are no contribution limits, it is important to note that in certain circumstances there may be additional taxes involved if contributions to a single beneficiary are more than $15,000 during the year.
If the child decides not to go to school, it’s possible to roll the account over into the name of another family member. If the funds aren’t used for education-related expenses, there may be taxes and penalties.
Generous family and friends can also contribute to a child’s college savings plan. They may choose to make deposits to an existing 529 account or set up one themselves, naming a beneficiary of their choosing.
Recommended: Benefits of Using a 529 College Savings Plan
Coverdell Education Savings Account
This account has more limitations but may offer more features for some. Individuals who have a modified gross adjusted income (MAGI) that falls below $110,000 ($220,000 if filing jointly) may be eligible to save for college using a Coverdell Education Savings account.
There can be up to $2,000 in contributions for a single beneficiary in a given year. Contributions are made after taxes and must be made in cash. Typically, the funds can be withdrawn without a fee to be used for qualified education expenses.
The Uniform Gift to Minors Act (UGMA) Account
This custodial account allows your child to own stocks and mutual funds. The custodian still controls the account until the minor reaches legal age. Note that it’s not tax-free.
Annual contributions that exceed $15,000 may be subject to gift tax. It’s possible that a UGMA may reduce the amount of financial aid eligibility. Additionally, there is no penalty should the funds not be used for education expenses.
IRA Accounts
Although generally used for retirement savings, IRAs can at times be used to pay for the cost of college. There are two types of IRAs: traditional and Roth. The main difference between the two:
• Roth IRA: The taxes on the account are paid up front and money withdrawn at retirement is generally tax-free.
• Traditional IRA: Taxes are paid when the money is withdrawn.
Generally, to make fee-free withdrawals from an IRA, the account holder needs to be at least 59 ½ years old. But IRAs can be used to pay for qualified education expenses, including tuition, books, and supplies.
Individuals can generally avoid the 10% early withdrawal fee if the account has been open for at least five years or if it is used for qualified education expenses.
Keep in mind that while there may not be an early withdrawal fee, the earnings withdrawn may still be subject to income tax.
Easing the Financial Burden
Even after years of diligent saving, paying the full cost of college tuition isn’t an option for some families. They simply can’t afford their children’s college education costs. In these cases, there are a few options to fill the gaps and help students pay for college.
Students getting ready to start college or those who are already enrolled could look into options like scholarships, grants, or private student loans.
Consider filling out the Free Application for Federal Student Aid (FAFSA®). This is the first step in qualifying for federal aid, including scholarships and grants, work-study, and federal student loans.
Scholarships
These can be a powerful asset when paying for college since it’s money that doesn’t have to be paid back.
Scholarships are typically merit-based and can be offered through a variety of different types of organizations like local nonprofits, corporations, or even sometimes directly from universities. There are a number of searchable databases that compile different scholarship opportunities.
Grants
These are also sources of funding that don’t need to be repaid. Unlike scholarships, grants are typically need-based.
The US Department of Education offers federal grants to students, including Pell Grants, Teacher Education Assistance for College and Higher Education (TEACH), and even Iraq and Afghanistan Service Grants .
Work-Study Programs
The federal work-study program provides part-time jobs for undergraduate, graduate, and professional students with financial needs. These jobs allow them to earn money to help pay education expenses.
Student Loans
There are two types of student loans: federal and private. Federal student loans are awarded as a part of a student’s financial aid package and can either be subsidized or unsubsidized.
Subsidized Federal Student Loans
Subsidized student loans are awarded to eligible undergraduate students based on need. The federal government covers the interest on these loans during the time the student is in school at least half-time, during the six-month grace period after leaving school, and during deferment periods.
Unsubsidized Federal Student Loans
Unsubsidized student loans are not awarded based on financial need, and are available to both undergraduate and graduate students. The borrower is responsible for paying the interest on a Direct Unsubsidized Loan from the time of disbursement. If the borrower chooses not to pay the interest while in school, during grace periods, or while in deferment, the interest will accrue and be added to the loan principal.
Private Student Loans
Private student loans are borrowed from a privately owned lending institution. Typically, for someone to get a private student loan, lenders will evaluate the borrower’s credit history, which isn’t the case with most federal student loans. This is why some borrowers rely on a co-signer to secure private student loans.
Typically, borrowers will be required to begin making payments on private student loans right away, even while they are currently attending school.
An Alternative Way to Finance College
Some parents might consider taking out a parent-student loan to help their kids pay for college. The federal government makes Direct PLUS loans available to parents and graduate students.
The interest rate for the 2020-2021 school year on a Direct PLUS loan is 5.30% and it’s fixed for the life of the loan. It’s recommended to exhaust all federal benefits first.
Saving for Yourself
Saving for your child’s education is important, but so are your other financial goals and priorities like setting up an emergency fund and saving for retirement. A realistic financial plan and budget could be a useful tool to help you as you work toward each of your goals.
Some private lenders, like SoFi, offer private parent student loans. SoFi’s parent-student loans have flexible terms and offer a competitive interest rate to those who qualify. It takes just a few minutes to see the rates you pre-qualify for.
The Takeaway
It’s never too late to start saving for college. There are a variety of accounts that are specifically designed to help families save for their children’s future college education, including 529 savings plans and Coverdell Education Savings Accounts.
Beyond savings, students and their families rely on things like scholarships, grants, and student loans to help cover the cost of higher education.
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