Parents of students heading back to school this month are finding it harder than ever to pay for that education. The cost of college has continued to rise while college savings plans—like most investments—are still recovering from the recent downturn. Meanwhile, the credit crisis has narrowed borrowing options. However, whether you have some time before your children are college-aged or not, there are things you can do to help keep their dreams and your hopes for their futures on track.
First, you should know that—barring some major change in the structure of our educational system—tuition increases are a mathematical certainty. Between 1987 and 2009, U.S. college tuition and fees increased an average of 6.8 percent annually, typically outstripping the rate of inflation, according to a June 2009 article by Seeking Alpha, a provider of financial news and analysis. Some evidence suggests that the recent financial crisis may have impacted college endowments substantially enough to necessitate bigger increases in coming years. Regardless, the cost of college will continue to rise.
If You Have Time, Consider a 529
Since most college savings plans invest in stocks, bonds and/or mutual funds, most are just now recovering from the crash that took the markets to 12-year lows last March. While a drop of that magnitude could be a major stumbling block for parents of college-aged children, it may be only a minor setback for parents planning further out. If you haven’t already, consider establishing a 529 plan. These state-sponsored plans provide a tax-advantaged way to set aside money for the cost of a child’s education while taking full advantage of compounding over time.
A 529 plan lets family and friends make contributions, which may qualify as income tax deductions in many states. These contributions grow tax-deferred and are not subject to federal tax upon withdrawal if used for qualified education expenses (although the earnings portion of any non-qualified withdrawals will be subject to a federally mandated 10-percent penalty and will be taxed as ordinary income to the recipient). And, 529 plans feature accelerated gifting techniques, which offer the option for donors to maximize their contributions in a single year. This could help bridge the financial gap faster for children who are closer to college age.
Don’t Overlook Federal Aid
Many families think they’re too wealthy to qualify for federal aid. That belief—and the sheer size of the Free Application for Federal Student Aid (FAFSA)—may discourage parents from filling out the form. However, even if you are ineligible for need-based grants, applying for federal aid opens doors to options like lower-interest loans, often with better repayment terms, which might be very useful if your child is at or approaching college age in the current economic environment. Visit fafsa.ed.gov to learn more.
Is the Money in Your House?
While reduced property values and tighter credit markets may make borrowing against your home more difficult, for people with significant assets and good credit, it could make the most financial sense. Home equity loans often carry very competitive rates. Also, interest on home equity loans of up to $100,000 can be tax-deductible if the funds are used for education.
Private lending, particularly in the current environment, should only be an option of last resort.
Regardless of your personal circumstances, there are several options you can exercise today. If you have some time, say four years or more, before you need to start paying your child’s tuition, talk to your financial advisor about a 529 savings plan. If the need is more immediate, fill out the FAFSA form and file it. Regardless of your child’s age, you should talk to your financial advisor to find an approach that makes the most sense for your specific financial situation.
Investors should consider the investment objectives, risks, charges and expenses associated with a 529 plan before investing. This and other information is available in a plan’s official statement. The official statement should be read carefully before investing. Depending on your state of residence, there may be an in-state plan that provides tax and other benefits not available through an out-of-state plan. Before investing in any state’s 529 plan, you should consult your tax adviser. iBi
Scott K. Elger, senior vice president and financial advisor at the Peoria office of Robert W. Baird & Co., has more than 20 years of financial services industry experience, and can be reached at (309) 677-5855 or (800) 274-4160.