When it comes to saving for college, there are lots of options to study. Here are the basics of what you need to know.
According to the College Board, the average cost for out-of-state tuition and fees at public four-year colleges for the 2013-2014 school year was $22,223. For private schools, the cost was just more than $30,000 annually.
Although the published sticker prices for college often exceed the prices students actually pay, there’s no doubt that sending a kid to college is an expensive proposition.
Here’s this week’s reader question:
I want to start a college fund for my son. Can you tell me how to go about doing it and which college fund would be the best one to start. — Robert
Before we get to Robert’s question, here’s a video I did a few months ago about how to finance college without borrowing. It could come in handy some day for Robert and his son.
Now let’s get to Robert’s question. The following is a list of the best ways to fund a college education. We’ll start with 529 plans (named for the section of the IRS code allowing them), then move on to other ideas.
The 529 plans are a great way to save for college for the same reason your 401(k) plan is a great way to save for retirement. Namely, income tax savings. Like a qualified retirement plan, earnings in these plans grow tax-free.
Every state, along with the District of Columbia, offers some type of 529 plan, either a college savings plan, prepaid tuition plan, or both.
Unlike your 401(k) at work, there’s no federal tax deduction for 529 contributions. But two-thirds of states offer a state tax deduction for residents, and six states — Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania — offer a tax break for any state’s plan.
We’ll explore college savings plans first, then look at prepaid tuition plans.
College savings plans
These plans are very similar to tax-advantaged retirement plans, such as 401(k)s. You put in as much as you’re allowed, choose an investment option, then hope your contributions earn enough to meet your needs when college rolls around. Earnings are tax-free if used for any qualified college expense, including tuition, fees, and room and board. If one kid ends up skipping college, you can substitute a sibling, or even use the money yourself if you go back to school.
Potential drawbacks: If you end up not using the money you put away in a 529 plan, you won’t lose it. But you will pay a 10 percent penalty and income taxes on the earnings (not the principal) for any non-education withdrawal. So you want to be fairly sure someone in the family will ultimately hit the ivory halls.
Another potential drawback is that these plans also aren’t terrifically flexible. Investment options are limited and can typically only be changed or transferred to another plan once yearly.
What to look for: If you live in a state with income taxes, you’ll obviously want to use your state’s plan if it offers a state tax deduction. If you’re able to shop around among various states, however, look for plans with low expenses. As with your 401(k), low expenses mean higher earnings.
Vanguard offers a calculator that will quickly let you know if your state offers a tax deduction and how much that deduction will be based on your contributions and income. Another place to see state deductions is this page of FinAid.org.
Who has the best plan? There are several places you can go to search for the best-performing and lowest-cost college savings plans. Kiplinger offers a search here. They also have a list of their favorite plans based on various criteria on the same page. As of August, these were their favorites:
- Lowest cost — New York’s 529 College Savings Program Direct Plan.
- Best mix of investment choices — Utah Educational Savings Plan.
- Best age-based portfolio for aggressive investors — Maryland College Investment Plan.
- Best age-based portfolio for conservative investors — Utah Educational Savings Plan.
- Best if you prefer safety over growth — Virginia’s CollegeWealth plan.
- Best adviser-sold plan — Virginia’s CollegeAmerica plan.
If you’re expecting everyone judging these plans to agree on the best, however, you’ll be disappointed. They don’t.