Alternatives for college funding: a primer

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Although we all know that “time flies,” it seems to move particularly fast as we watch our children grow. Yet, in considering a college future for a newborn, it is understandable that parents might procrastinate, since seventeen years seems so far in the future. However, when it comes to planning for college, children progress all too quickly from the cradle to the college classroom.

Moreover, college tuition costs keep increasing on a yearly basis, although the pace of the increases has slowed in recent years. While 10% annual increases were common in the 1980s and early 1990s, The College Board projects smaller yearly increases as we progress further into the twenty-first century. Still, with the average cost at private colleges exceeding $31,000 per year (Source: Trends in College Pricing—2000, The College Board), the projected four-year cost at a private college for today’s newborn is staggering.

These numbers can easily overwhelm you, especially if you are already juggling other financial concerns. However, the sooner you start saving, the better. The longer you delay, the more difficult it may be to reach your funding goal. Even if you can only afford to begin putting away a small sum, saving on a regular basis may pay off in the long run.

  • Personal savings are especially important as a source of college funds, since it’s the one area over which you have the most control. While other sources of education funding are also available, it helps to understand what to expect before counting on them.
  • Financial Aid. This usually comes in the form of loans, and may not cover the total college costs. Even if your child qualifies for financial aid based on need, there is no guarantee your chosen college will have sufficient funds to help all who fit that category.
  • Scholarships. Many scholarships—both large and small—exist, yet there is no way to predict whether your child will qualify for one, or receive one even if he or she is eligible. Scholarship opportunities are available locally, statewide, and nationwide.
  • Coverdell Education Savings Account. This education savings vehicle allows nondeductible annual contributions of up to $2,000 per child under the age of 18. Contributions enjoy tax-deferred accumulation and can be withdrawn tax free if used for education expenses. Certain income eligibility limits apply. In addition, income taxes and a 10% income tax penalty may apply for nonqualified distributions.
  • Tax Credits. The American Opportunity Credit gives families a maximum tuition credit of $2,500 per year per student for the first four years of post-secondary education—100% of the first $2,000 of tuition, and 25% of expenses in excess of $2,000. The Lifetime Learning Credit gives a 20% credit toward the first $10,000 of qualified education expenses (tuition and/or other educational expenses incurred to learn or improve job skills). This credit is available to college juniors and seniors, graduate students, and working Americans. Using one of these credits offsets the use of the other.
  • State-Sponsored 529 Savings Programs. Many states are beginning to adopt 529 plans, which are named for the section of the Internal Revenue Code (IRC) under which they are established. Although many details of these plans vary by state, they generally come in two forms: Prepaid tuition programs allow participants to “lock in” tuition rates at eligible state colleges or universities with a lump-sum investment or monthly installment payments. The contract value may also be applied to private or out-of-state schools (although possibly not at full value, depending on the state). Savings programs allow contributions to vary and can be applied at any accredited institution of higher education nationwide. Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship fund, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
  • Personal Loans. These are usually easily available, although with interest charges they may prove costly over the long run. Personal loans may also require payments to begin and interest to start accruing immediately.
  • Future Personal Income. If you haven’t managed to set aside funds by the time your child is ready for college, how will you fund an entire college education out of your income while he or she is attending school? This may prove difficult, especially if you will be nearing retirement age at the same time.

With uncertainty surrounding all funding options except savings, it’s important to consider personal savings when planning your college funding program. Put time on your side—start your child’s education fund now!

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Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by Liberty Publishing, Inc.

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The opinions and views in this blog post are those of the authors, and are not intended to provide specific advice or recommendations for any individual. Please consult professional advisors with regard to your individual situation.

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