By Susan Doktor
See that cooing, cuddly bundle of baby love you’re rocking in the cradle right now? You’ll be sending him or her off to college in the blink of an eye.
Don’t believe me? Ask one of the millions of parents who came up short-handed when tuition bills were due because they didn’t plan ahead. Some financial experts advise anyone even thinking of having children to start saving for their college expenses long before their bouncing babies arrive. So if you want your kids to reap all of the benefits of higher education, the time to start building a college fund is now — or even yesterday.
The Cost of Higher Education
Fair warning: we’re about to give you some daunting figures. According to the Education Data Initiative, the average in-state student at a public university spends nearly $26,000 per year — $9,377 of it on tuition. That figure jumps to over $54,000 for students attending a not-for-profit private college, including about $37,000 for tuition. Those figures do not account for the income students lose when attending college full-time. If you’re the parent of young children, you can expect the cost of higher education to increase by the time they’re college-age. Over the past 20 years, in-state tuition at a public university has increased by a jaw-dropping 175%. And they’re not decreasing any time soon.
How Much Should You Be Saving for College?
That depends on how much of your kids’ total college expenses you hope to pay for. If you want to foot the entire bill for a public university degree, you’ll need to save $5,777 per year or about $481 per month. That’s if you start saving when your child is born and have 18 years to reach your goal. Many parents don’t start that early. And many parents don’t have that much extra income to set aside each month. That’s where educational financing comes in.
Most families finance a large portion of college expenses through student loans. Student loans are a godsend, but they’re a double-edged sword. You’ll pay interest on every cent you borrow. At today’s federal loan interest rate — currently 4.99% — if you take out a ten-year student loan to finance your entire bachelor’s degree, you’ll pay upwards of $6,000 on interest over the life of your loan. Private loan interest rates can be higher or lower, depending on whether you have excellent credit, poor credit, or somewhere in between.
What’s the Best Way to Save for College?
Financial experts vary on the answer to that question. But it’s not by sticking your savings in a low-interest savings account. And it’s not by investing your savings in high-risk stocks, cryptocurrency, or NFTs. Smart investing is always a question of balancing risk and reward. But when you’re saving for something as important as college, it’s best to take a cautious approach.
We’re tax advisors. So, not surprisingly, we’re going to tell you about the most tax-advantageous way to start saving for college. It’s called a 520 Savings Plan.
Why a 529 Savings Plan?
The first 529 College Savings Plan was launched by the state of Michigan in 1986. It was designed to encourage and incentivize families to save for future college expenses. On average, the median income for college graduates is 84% higher than for students who earn just a high school diploma. College graduates are less often unemployed over the course of their careers. Higher education contributes to a higher standard of living.
Today, all 50 states and the District of Columbia sponsor at least one. Saving for college through a 529 plan can simultaneously help you reach your college savings goals and reduce your taxes. Here’s why.
- In most states, the money you contribute to your plan is tax-deductible on your state income tax return. Saving $5000 a year in a 529, as in our example above, has the potential to push you into a lower tax bracket, which can add considerably to your tax savings.
- As your money grows, you’re not taxed on the income your plan returns. And when your child reaches college age and you begin withdrawing money for qualified educational expenses, your withdrawals aren’t taxed either.
- While there is no federal tax deduction for your contributions to a 529 plan, the income your savings generates isn’t subject to federal taxation. Nor are withdrawals for qualified expenses.
More Ways to Maximize Your Tax Savings
If you aren’t working with a tax planning professional to maximize your tax savings, you may be missing out on several opportunities and paying more in taxes than you have to. A Certified Tax Planner is trained to help you harvest all of your tax benefits and will comb through your financial life to find them.
For example, the US government encourages residents to invest in higher education by offering several other tax incentives:
- The American Opportunity Credit allows parents with college-aged dependents to claim up to $2,500 per student per year for the first four years that they’re working towards an undergraduate degree. Independent students can claim this credit for themselves, as well. You must meet certain income qualifications and several other criteria to take advantage of this credit. To fully claim it, your adjusted gross income must be below $80,000 (or $160,000 for married couples filing jointly). Students must be attending school at least half-time for this credit to apply. Note that the AOC is available for four years only. With the AOC, you may even get a tax refund if the credit amount exceeds the amount of tax you owe.
- The Lifelong Learning Credit is available for individual tax payers who earn between $58,000 and $68,000 per year ($116,000 to $136,000 for married couples filing jointly). You can deduct as much as $2000 on your return with the LLC. The LLC covers undergraduate, graduate, and professional degrees. There’s no limit on the number of years you can claim the LLC and students need not be enrolled half-time. Taking a single course or two during a tax year can qualify a student for this opportunity.
- Under certain circumstances, the interest you pay on student loans for your children may be tax deductible. To take advantage of this deduction, the student loans your kids benefit from must be taken out in your name and you must make all of the payments in their name. Here’s one example of how planning ahead can benefit you. While it may be possible for your kids to take on student loans in their own names, from a tax perspective, that may not be the most conservative approach.
Meeting the Challenge of Paying for College
Funding higher education is not easy — but there are steps you can take to make it easier. A Certified Tax Planner can help you develop a long-term strategy to cover the high cost of tuition for your kids. Certified Tax Planners know how to navigate the many rules surrounding higher education tax deductions so you don’t run afoul of regulations, and will ensure you don’t overlook more sophisticated strategies that you might qualify for by taking some proactive actions. Starting early and having top-notch tax advice along the way are the best ways to meet your educational funding goals. Visit our directory to find a Certified Tax Planner near you.