How to Pay for College: Funds, Savings, and Alternatives

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Undoubtedly, the most complicated part of going to college is paying for it. But, the benefits of going through life with a degree make the troubles of college funding worth it. Unfortunately, the cost of attending college is determined to touch the sky and doesn’t seem to let up anytime soon. The average cost for an in-state college for the 2012-13 school year, without financial acid, rose 3.8% to a record of $22,261. Not only is tuition increasing, but all sorts of expenses, big and small, are on the rise, including residence, meals, books, and countless other expenditures that come with living a life away from home. But, the financial aid budget remains stagnant, leaving students (and of course their parents) to cover these additional costs themselves. Therefore, the college cost after scholarships and other aid rose 4.6% to an average of $16,510. However, the inflation rate rose just 2% over the past year—these figures just don’t match up. So how should one go about paying for college? Read on to explore your options.

Types of College Funds

Two main ways exist to meet college expenses: tax-advantaged investments accounts, which include Section 529 Plans and Coverdell Education Savings Accounts), and prepaid tuition plans. Let’s see what these options encompass.

Tax–advantaged investment accounts

Tax–advantaged investment accounts are more flexible in terms of where your student will attend school and how the saved money can be used.

  • Section 529 Plan

A 529 Plan is a savings plan run by the state or an educational institution to help families set aside college funds for the future. This account, which can be opened for as little as $5, is extremely flexible with virtually no restrictions. Anyone can set up such a plan regardless of income, age, or relation to the future college student. Funds can go toward any school in any state for tuition, residence, meals, and such without tax on withdrawals. Not only does a 529 Plan offer tax-free growth on investment, but any person can contribute up to $60,000 per child annually, again, without having to worry about federal gift taxes. A 529 Plan is probably one of the easiest and smartest college fund options out there.

  • Coverdell Education Savings Account (CESA)

A Coverdell account allows parents or relatives to save up to $2000 per year to help fund a child’s college expenses. Not only are withdrawals tax and penalty free for expenses related to higher education, but also spending on elementary and secondary school expenses may be allowed as tax-free spending. However, if the money in the account has not been used by the time the child turns 30, the remaining amount will be distributed and taxed. The account may be turned over to another eligible family member under 30 for his/her education needs.

Pre-Paid Tuition Plan

A pre-paid tuition plan allows you to pay for college (at today’s rates) for school in the future. Your account will pay the tuition at the participating schools by the time your child is ready for college. The benefits of this plan include protection from inflation, rising tuition costs, and stock market fluctuations. Also, the funds are tax-free and offer some flexibility in terms of being able to switch the beneficiary to an eligible family member, which includes the siblings, step-siblings, and first cousins of the existing beneficiary. However, this account does not cover room and board expenses and you are limited to the colleges and universities participating in this pre-paid tuition plan.

But How Much Should We Save?

Say your child is a one-year-old and you’re not sure how much you need to save every month to have enough to pay for college 17 years down the road. Find out the rate your money will grow annually to then calculate how much you should set aside each month to be able to save enough to fund your child’s college education. Say you expect your money to grow at 7% and you have 17 years before your child heads off to college. If you have $25 transfer automatically into your 529 Savings Plan each week, you’ll have $39,000 by the time your child is 18. Or you can enter the numbers into an online college saving calculator to figure it out. Remember, though saving might seem a little difficult now, it is much easier and smarter, money-wise, to save now instead of borrowing (with high interest rates) later.

Alternatives to a College Fund

Some people don’t think that a college fund is right for them as all the money must be used up by a certain time and for education purposes only, lest it be subject to taxes and penalties. But before you even think about saving up thousands of dollars for your child make sure that your own future is secure. Remember to set aside enough money for not only your child but also your own retirement. Money that you put into a college savings plan for your child will not be available for your own personal use in the future if you child doesn’t use it.

  • Many people like to simply have money automatically transferred into a regular savings account. This way your periodic contributions won’t be skipped and your money will be safely accumulated.
  • Some parents like to invest money that would otherwise be sitting in a college fund in stocks instead because of the chance to grow the money quicker. However, risk is synonymous with stock market. Make sure the stakes aren’t too high as to risk your child’s future entirely.
  • A safe and easy option is to buy U.S. Savings Bond. Under the Education Savings Bond Program, you don’t need to pay tax on the bonds that are used to pay for college. Your money will remain extremely safe, but not without significant drawbacks which include income limitation, qualification restrictions, minimum time bonds must be held, annual purchase limits, and a low rate of return.

If you’re looking for an alternative to a traditional college fund like the 529 Plan, your options are extremely limited. However, if you do want a way to ensure that you have access to the money regardless of how much of the fund your child uses, go ahead and consider the above options.

The value of a college education is priceless. A degree opens up countless new doors in the increasingly competitive market. On average, college graduates earn $1 million more than high school graduates during their career, according to the U.S. Census Bureau. Saving for your child’s college education now is the biggest investment you can make for his or her future.  

This was a guest post from Angie Picardo, a staff writer for NerdWallet. Her mission is to help consumers stay financially savvy, and save some money with the best savings account interest rate.

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