I am often asked my thoughts on saving for a kid’s college. With the price of today’s college tuition, there is no wonder why! Parents can and should be planning for this, since the average yearly cost of a public out-of-state college is over $36k a year and growing (Source: CollegeBoard)

First, as parents we need to decide how much to have ready for your kids college needs. Although covering 100% of their costs would be nice, it may be stressful and unrealistic for many families. Perhaps half?  Maybe you will save as much as you can afford to save? Remember, you don’t want to necessarily postpone your retirement just so they can go to school – particularly because you have limited options to fund your retirement while your kids will have multiple options to pay for school. But I would concentrate on saving more (and saving early!) versus borrowing and getting involved with mounds of student loan debt.

From there, we have several options. Not that I can cover all the talking points in a blog post – one can probably write an entire thesis on it – but here’s some of my thoughts as well as various strategies to consider.

Pre-Paid Tuition Plans

Pre-paid tuition plans allow investors to purchase tuition now, at current rates, which can be used for a student at a future point in time. The tuition can be purchased in monthly installments or as a lump sum. These plans are offered by individual states, and over the years fewer states have made these available. Currently only 11 states make it available (click here for the list) and it’s important to note that the main benefit of these plans is when the student stays in-state. So as a parent, you want to be fairly certain that your child will staying local…otherwise the you may face a penalty or at best, get your original contribution money out to use at any other school (with no years of investment growth).

529 Savings Plans

First launched in 1996, these college savings accounts have steadily gained in popularity and now have hundreds of billions of dollars in them. As with most things, there are pros and cons – but the benefits of this route make it very appealing to most families. First of all they are flexible, and unlike prepaid state plans – these accounts grow with various investment options and can be used for schools in any state. The earnings in the account are federally tax free if withdrawn for education related expenses. Money can be taken out for costs of room and board, tuition, fees, books/supplies, and most computer related equipment. Recent law changes also allow for funding of pre-college (ie private school) too, so you can possibly use it sooner than age 18.

Another benefit of the 529 plan is some states (PA, CO, others) offer tax benefits if residents use the 529 plan for that state. And I often encourage people to use a plan which works with UPromise, a rewards program which provides cash back contributions into the 529 account.

Other Common Savings “Buckets”

Some parents prefer to not devote large quantities of money exclusively for education, therefore then like the flexibility of opening a UTMA/UGMA account for their child. Commonly known as “custodial accounts”, these funds do have some tax benefits, but the main distinction is the funds can be used for any purpose as long as it’s for the benefit of the child. It can buy them their first car, be used towards a house/wedding, or fund their education. But since the funds are in the child’s name – they can choose to buy beer with it once they reach age of majority. So there’s that possibility. Once again, the different rules may or may not be what you want.

Another option is an “Educational Savings Account” (ESA). The money in these accounts can also grow tax free and be used for education expenses. The major downside is the $2,000 maximum annual contribution limit and even if you add the maximum for 18 years, that’s only $36k saved. For some, the ESA may not be enough. But it’s an option nonetheless.

If none of these special account types appeal to you, parents always have the option to save in accounts in their own name. There aren’t many tax benefits of doing this, but you would have complete control and flexibility over how the money was invested and used.  And if you don’t need it (or want to give it) to your kids for education, the money is in your name and continues to stay that way.

Other Unique Investment Strategies

There are two other strategies that parents may consider in addition to those mentioned above. One plus is that neither of these should affect the FAFSA form filing, since these are technically retirement assets of the parent and not income sources.

A parent’s Roth IRA is sometimes a sensible option to use for college savings, because these accounts allow for tax-free growth and you can withdraw the contributions without consequence. And if you are going to be like me – over age 60 by the time my kids are in college – there is no tax nor penalty to take out the earnings as well. My Roth IRA is set up and growing for my retirement, but if I needed an additional resource to help pay for my kids’ school – I like knowing my Roth is available.

Another option for parents is to buy some type of cash value life insurance. Without getting into too much detail, these types of insurance policies can be used as savings vehicles which can provide tax-free withdrawals of cash that grow within the policy. The benefits are two-fold: to protect your family in the event of your premature death, and by “fully funding” the policy (i.e. paying more than the necessary minimum premium levels) you can use it as an investment vehicle. It’s best to consult with a financial professional before exploring this route.

Here’s a simplified example of how it could work. A new 35-year-old mother in good health could get a $1mil life insurance policy and we could illustrate what would happen if she paid $500/month (@$6k a year, similar to an IRA contribution) for the next 20 years. After 20 years of payments, we assume she stops making premium payments. So what happens in this scenario? First, she would have the $1mil death benefit pass on to her heirs if she died. Second, the 20 years of premium payments ($120k total paid) in the policy ideally grows to something bigger. Even if it grew at a modest 5.6% rate, she’d have something closer to $160k built up in cash that can be taken tax-free from the policy. How’s that for another college funding option?[1]

In Conclusion

Sending our kids to college will be no small feat. Costs are climbing every day, and expected to continue. By no means is this post all-inclusive of the options that parents have, but it is a majority of the discussions that I’ve been having with people. I have used most of these strategies myself as I prepare for my 3 and 1 year old daughters to go college someday. Of course I would also encourage families to apply for financial assistance, scholarships, and grants…this may be a topic of discussion for another day.

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[1] I used many assumptions here, and of course there is a lot of legal disclaimers and such…but I tried to simplify 26 pages of an illustration into a couple sentences. There are costs within the insurance policy that get taken out, etc, and each illustration needs to be looked at carefully.

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