Andrea Lee | July 5th, 2022

College Savings Strategies

The cost of higher education has skyrocketed over the last two decades. Below are some 2022 numbers:

• The average cost of college has more than doubled in the 21st Century growing at 6.8% per year.
• The average cost of college is $35,331 per student year, including tuition, books, supplies, and living expenses.
• The average spending for an in-state student at a public 4-year institution is $25,486 per academic year.
• Average in-state tuition is $9,349, out of state is $27,023.
• The average private university student spends $53,217 per academic year, of that $35,807 is tuition and fees.
• The ultimate cost of a bachelor’s degree, when factoring in student loan interest and loss of income, can be greater than $400,000.

Many parents hope to fund their children’s education, but considering the numbers above, you’ll need smart college savings strategies to do it, so we’ll look at your options.

529 Plan

Of all the college savings strategies, 529 Plans are probably the most familiar.  State-run 529 Plans work similarly to a Roth 401(k) or Roth IRA. A 529 Plan allows you to invest in a selection of mutual funds, and the earnings grow tax deferred. The withdrawals are tax-free when the funds are used for qualifying educational expenses.

There is no federal contribution deduction, but many states allow a deduction or credit for plan contributions.

Pros

• Withdrawals can be used for up to $10,000 per year on qualifying K-12 expenses making 529 Plans an excellent option for parents who want to send their children to private school. The withdrawals aren’t subject to federal income or capital gains tax, and some states offer state tax benefits.
• Depending on the plan, max investments can exceed $500,000 over the life of the account, and deposits up to $16,000 per year per individual qualify for the annual gift tax exclusion.
• Contributions up to $80,000 in one year can be treated as if they were made over five years, allowing you to shelter a larger amount from taxes.

Cons

• Earnings will be subject to income tax and a 10% penalty if the withdrawal is used for something other than qualified education expenses.
• Investment options are limited to what the state’s plan offers.

Financial Aid Impact

• 529 Accounts owned by dependent students are treated as parental assets and don’t have to be reported on the FAFSA (Free Application for Federal Student Aid) when the money is withdrawn for college expenses.
• Withdrawals from accounts owned by anyone other than the student or a parent are included in the student's income on the FAFSA for the next year and can reduce their eligibility for aid by up to 50% of the amount withdrawn.

Coverdale ESA

A Coverdell Education Savings Account is a tax-advantaged trust or custodial account that can be used to save for educational expenses. The contribution limit is $2,000 per year and contributions are tax-deferred; the earnings are not subject to income or capital gains taxes when spent on qualified educational expenses.

Pros

• Withdrawals can be used for up to $10,000 per year on qualifying K-12 expenses making Coverdale ESAs another great option for parents who want to send their children to private school.
• There are many investment options to choose from, including self-directed investments.

Cons

• The max contribution is low at just $2,000 per beneficiary per year.
• All contributions must be made before the beneficiary turns 18, and the account can only be used before they turn 30.
• Couples making more than $220,000 per year or individuals making more than $110,000 per year are not eligible for a Coverdale ESA.

Financial Aid Impact

The account's value is considered a parental asset on the FAFSA, no matter if a parent or the student owns it.

UGMA or UTMA Custodial Account

A custodial account created under the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act is created by an adult to benefit a minor. The contributions are invested in stocks, bonds, mutual funds, etc., for a minor and transferred to the minor at age 18, 21, or 25.

Pros

• The money doesn’t have to be used for educational expenses; it can be used to buy anything so long as the purchase benefits the minor.
• The is no maximum on how much you can invest.
• The account's value is not included in the donor’s gross estate.

Cons

• Earnings and gains are taxed to the beneficiary and subject to the “kiddie tax,” meaning unearned income above $2,300 for certain children through age 23 will be taxed at the marginal rate applied to trusts and estates.
• Once the beneficiary reaches the age at which the account is transferred to them, they can spend the money any way they like.

Financial Aid Impact

The account is counted as a student asset on the FAFSA, so it can reduce aid by 20% of the account’s value.

Qualified Savings Bonds

U.S. Savings are debt securities issued by the Treasury Department, making them one of the safest investments available.

Pros

• U.S. savings bonds are federally tax-deferred and not subject to state tax.
• Series EE and I bonds purchased after 1989 can be redeemed federal tax-free when used for qualifying higher-educational expenses.
• U.S. savings bonds are as close to a risk-free investment as exists.

Cons

• The maximum investment is $10,000 or $20,000 for a married couple per year, per owner, and per type of bond.
• The interest exclusion is phased out for those earning between $128,650 and $158,650 (for 2022) for married couples filing jointly or $100,800 for individuals.
• When proceeds are not spent on tuition and fees, the earnings are included in federal income and taxed.

Financial Aid Impact

If the bond is in the student’s name, it counts as an asset they own on FAFSA. If owned by the parent, it’s reported as a parental asset.

Mutual Funds

Mutual funds allow money to be invested in various securities, most typically stocks and bonds and are professionally managed.

Pros

• The money can be spent on anything; it’s not limited to educational expenses.
• There is no investment maximum.
• There are thousands of mutual funds to choose from.

Cons

• You must pay annual income tax on earnings.
• Capital gains will be taxed when shares are sold.

Financial Aid Impact

FAFSA considers money from mutual funds as income.

Roth IRA

A Roth IRA is a tax-advantaged retirement account. You can contribute after-tax income, and the growth is tax-free. Withdrawals are tax-free after age 59 ½, and withdrawals taken to pay for college expenses are considered untaxed income to the student.

Pros

• Contribution withdrawals are not subject to a penalty.
• Withdrawals for qualified higher education expenses are not subject to a penalty.
• There are lots of investment choices available.

Cons

• For 2022, the maximum contribution is $6,000 and an additional $1,000 for those 50 and older.
• Married couples earning over $214,000 for 2022 or individuals earning over $144,000 are not eligible for Roth IRAs.

Financial Aid Impact

Retirement accounts are not counted as assets on FAFSA, but withdrawals from a Roth IRA to pay college expenses are considered base-year income.

Permanent Life Insurance

Permanent life insurance is a type of insurance policy that doesn’t expire as long as the premiums are paid. The benefits are paid to the beneficiaries upon the policyholder's death.

Permanent life insurance has a savings or investment component that builds cash value which the policyholder can borrow against or withdraw from during their lifetime, and that money can be used to pay for educational expenses.

Pros

• The money can be used for anything.

Cons

• Permanent life insurance has initial and recurring fees, often up to 2% per year.
• It can take a decade or longer for the policy's cash value to surpass what you’ve paid in premiums.
• Any outstanding loans at the time of the policyholder’s death lower the benefit to the beneficiaries.

Financial Aid Impact

Life insurance is not counted as an asset on FAFSA.

Making the Right Choice for Your Family

With so many choices available when it comes to the best college savings strategy for your family, it can be challenging to make the right call. If you’d like to discuss your options, you can schedule an appointment here.

The opinions voiced in this letter are for general information only and are not intended to provide specific advice or recommendations for any individual.

Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.