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Welcome back to Money 101, Invest in You: Ready. Set. Grow’s eight-session guide to financial wellness.
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Today, our challenge is college savings. If you have kids, or are thinking about having them in the future, you want to be prepared long before it’s time to send them off. And you want to do it in a way that isn’t going to make you broke.
From 529 savings plans to financial aid, there are a lot of different options to pay for college. We’ll sort it all out so you can figure out the right move for you.
Thanks again for joining me — and happy learning!
CHALLENGE #5: SAVE FOR COLLEGE
The first thing you need to do is determine how much money you will need. You can find college cost predictors through brokerage houses, banks and other financial websites, like the one on TRowePrice.com.
529 savings plan: This state-sponsored plan allows your earnings to grow tax-free and doesn’t make you pay taxes when you withdraw the money. It can be used for tuition, fees, room, board, books and supplies and other equipment. You can invest in any state plan, and the beneficiary can use the money to attend any college or university in the country. You can also use the money in a 529 plan to pay for up to $10,000 a year in tuition expenses at elementary or secondary private or parochial schools. If you are struggling with college debt, you can also use 529 plan money to pay off up to $10,000 in qualified student loans over the lifetime of a beneficiary and $10,000 for each of the beneficiary’s siblings.
However, you’ll be hit with a 10% penalty and will have to pay taxes if you use the money for non-qualified expenses. If your child doesn’t use it, you can change the beneficiary to a sibling, another relative, friend or even yourself.
Prepaid tuition plan: You can lock in your kid’s future tuition at today’s rates by investing in a 529 prepaid plan.
Withdrawals are also tax-free when used for college expenses, but generally only cover tuition and fees. These plans are more conservative investments. You’ll likely wind up with more money if you invested in a 529 plan.
Coverdell education savings account: This savings plan also has tax advantages and is more flexible than a 529 plan, allowing you more control over your investments. It also can be used to cover most K-12 private educational costs, including academic tutoring or a laptop. However, you can only save up to $2,000 a year per student.
Unlike a 529 plan, there is also an income cap. If you make less than $95,000 as a single filer or $190,000 as a couple, you are eligible for the full yearly savings. The max gets gradually phased out until $220,000 for a couple or $110,000 for single filers.
Roth IRA: As long as you have had it for five years and are at least 59½, you can start withdrawing tax-free funds from your Roth IRA. This could be a good option, combined with a Coverdell savings account.
Save in your own name: You may opt to put some of your child’s college savings into your own personal investments, since dividends and capital gains are taxed at 0%, 15% or 20% for 2021, depending on your income.
Look for a tax-efficient investment, such as a stock index fund or exchange-traded fund. When you sell the investment, you can gift some of the money to take advantage of the lower taxes on gains. However, taxable accounts don’t come close to the compounded returns of a 529 plan.
Check out savingforcollege.com for comprehensive coverage of the various college savings options. You can compare various plans, including contribution limits, tax treatment and impact on financial aid.
Don’t assume you may not qualify for financial aid. Experts advise that all students apply.
In 2021–22, undergraduate and graduate students received nearly $235 billion in college aid - including grants, federal work study money, federal loans, and federal tax credits, as well as financial aid from state governments, colleges, universities and private organizations. Government aid is based on information on a student’s Free Application for Federal Student Aid (FAFSA). Public colleges follow it pretty closely and private ones also factor it into their offers.
The government determines your expected family contribution (EFC) by weighing your income, your assets, family size and number of children attending college. The difference between the EFC and the actual cost is your financial aid.
To get non-governmental aid, you can turn to the College Scholarship Service, offered by the College Board. It’s used by almost 400 colleges, universities and scholarship programs.
Students can also apply for grants such as the federal Pell Grant, which is based strictly on need. Go to studentaid.gov for details on the federal grants available. Schools’ grants are usually a mix of need-based and merit-based.
“Education is the key to unlocking the world, a passport to freedom.”―Oprah Winfrey
If saving ahead of time wasn't in the cards and financial aid can't cover the full cost of higher education, taking out loans are another option. Whatever you do, please don't charge tuition on your credit card!
Loans for students: Known as a Stafford loan, students can apply directly through the federal government’s program.
Subsidized direct loans are based on need, while unsubsidized loans are not need-based. The interest rate for both for undergraduates is currently 4.99% (until July 1, 2023). A dependent student can take out a total $27,000 for their four-year college career, but only a maximum of $19,000 may be subsidized.
You can also explore private loans, but each lender has its own set of requirements and rates. Check out StudentLoanHero.com’s list of recommended private loans.
Loans for parents: Through a federal Direct PLUS Loan, parents can borrow up to the total cost of four years of college, minus financial aid. There is no income limit. The current rate is 7.54% (until July 1, 2023).
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