Tips for figuring out how to pay for college from CFP/CPA Howard Hook of NJ’s EKS Associates
(Princeton, NJ, MAR 17, 2021) -- Advancing one’s education often comes with a high price tag. Figuring out how to pay for college can be daunting.
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Today, private schools can cost as much as $75,000 per year, and many state universities (even those in the state you live) can cost more than $100,000 for four years.
These costs seem to separate the “haves” from the “have nots.” Yet, as a parent or grandparent, you can do a great deal to help level the playing field.
In an ideal world, you should begin planning how to pay for college when your child is born. This preparation allows your funds to grow over the next 18 years.
Of course, this is not always possible. So, what are your options? Here are a few strategies to help you pay for college.
Paying For College With Savings
529 plans are state-sponsored plans that allow for tax-deferred growth with very high contribution limits and no income phase-outs. If the funds are used for qualified expenses, such as tuition, room and board, textbooks, and computers, withdrawals are tax-exempt.
However, should the funds be withdrawn for non-qualified expenses, you must pay ordinary income tax on the earnings and a 10% penalty. There are no federal taxes or penalties applied to the original contribution. There can, however, be state tax implications.
Contributions to 529 plans are considered gifts. In 2021, the annual gift tax exclusion is $15,000 per person, per beneficiary. If you intend to contribute more than that amount, we recommend speaking to your tax advisor.
Almost every state offers its own 529 plan, and you don’t have to live in the state where you purchase the plan. Some state plans also provide a tax deduction if you are a resident of that state. To find the best 529 plan to help you pay for college, consult with a qualified financial planner.
Investments in Non-Retirement Accounts
You can use after-tax monies that have been saved in a non-retirement investment account to pay for college. This strategy might be more advantageous than a 529 plan if you want ongoing flexibility in using the savings.
In other words, you can use this savings for anything, not just education expenses. The downside is that if you choose to use it to pay for college, you don’t receive the same tax advantage that you would with a 529 plan.
Another way to pay for college is by taking a loan from your 401(k) plan. There is a limit on the amount you can withdraw, usually the lesser of $50,000 or 50 percent of the 401(k) account’s total value. This may be more advantageous than a private bank loan because you pay the interest rate back to yourself. Typically, these loans are due back within five years, and if repaid on time, you will not pay any taxes.
There are a few downsides to be aware of as well. Since there is a limit on how much money you can withdraw, it probably won’t cover all your college expenses. It can also negatively impact your retirement date since you are drawing down your retirement savings. Lastly, if you don’t repay the loan timely, the amount not repaid will be taxed as ordinary income, plus a 10% penalty if you’re under 59 ½ years old.
Paying for college with monies from a retirement plan is an option, but not always the best one. Remember, you can always borrow money for education planning, but you can’t borrow money for retirement.
Other Ways To Pay For College
Should saving for college not be possible, all is not lost. There are other avenues for students to pursue. Here are some additional ways to pay for college.
Most scholarships are based on academics, sports, or other extracurricular activities. Students should begin researching and applying for scholarships during their sophomore year of high school. Understanding what the eligibility requirements are ahead of time allows you and your student to get proactive in your college planning. For example, your student may want to take additional AP classes or volunteer more so they qualify for a specific scholarship by their senior year.
We usually recommend every child apply for financial aid due to it being widely available. There are eligibility requirements, of course, such as the student’s merit and financial need. Financial aid can include various federal grants, scholarships, federal student loans, and work-study opportunities. To determine if your student is eligible, complete the FAFSA (Free Application for Federal Student Aid) application.
Private Student And Parent Loans
Private loans enable you to borrow money from a lender (e.g., a bank or credit union) and pay it back later with interest. Private loans are different from grants and scholarships, which do not need to be repaid. These loans typically come with fixed or variable interest rates that can be high, and students may be required to have a co-signer. Private loans should be your last resort, as they carry the highest repayment costs.
With so many loan options available, it can be overwhelming. Savingforcollege.com published a helpful article explaining the difference between federal student loans and private student loans<https://www.savingforcollege.com/article/differences-between-federal-student-loans-and-private-student-loans>.
How To Reduce The Cost Of College
There is another strategy worth mentioning here. Attending community college for one or two years and then transferring to a four-year school may accomplish a few goals.
First, community college typically runs about $3,000 per year, offering a tremendous cost savings. Second, not every 18-year-old knows what they want to be when they grow up, and community college offers them an opportunity to mature and explore different career paths, before committing to a major. Lastly, it can improve a student’s chances of admission to a school they may not have qualified for out of high school.