Do you have a child or grandchild you hope to send to college – whether that’s soon or years from now?
If so, you need to plan just as much as they do – if you’re the one who will handle many or all of the bills.
The coronavirus pandemic appears to have slowed year-over-year tuition increases at U.S. colleges and universities – at least for now.
Average tuition and fees at private colleges have increased by only 1% for the 2021-2022 school year, according to a U.S. News & World Report survey. It also found that both in-state and out-of-state tuition and fees at public schools have increased, on average, by around 1% to 2%.
Still, college isn’t cheap. The cost of education remains a financial challenge for many families. The average tuition at a private college is still around $38,000 a year … and that doesn’t even include room and board!
This means you still must engage in sound financial planning when saving for college tuition and expenses. In doing so, here are three mistakes you should avoid:
1. Using home equity to pay for college
This strategy may allow the child to attend college, but it can all but destroy your own retirement plans. How so?
Perhaps you bought your house when you were in your 30s. With a 30-year mortgage, you knew it would be paid off in your early 60s – around the time you expected to retire. Now that you have a great deal of equity in the house, you could pull out thousands of dollars to send one or more children or grandchildren to college for four or five years.
That’s great for the children, but what about your retirement? If you take this route, you could end up three or four times deeper in debt than when you bought the house – and you are 80% closer to retirement. The result: You won’t pay off your mortgage until you’re well into your 80s – a good 20 years after you planned to retire.
2. Using college tuition prepayment plans
Many individual schools and states sponsor these programs, in which you send in a certain amount of money now (usually the current tuition cost), and they promise that college will be paid for when your child or grandchild turns 18.
But here are some of the problems:
- These college savings plans cover tuition only – not room and board, which accounts for 40% to 60% of the cost of college.
- The child is not guaranteed to be accepted to the school.
- Prepaid plans require that your child attend an in-state public school. The child might not want to go to that particular school, to a school in that state, or to any school. In some programs, refunds are limited to the amount you paid, with no interest.
- Programs in many states haven’t succeeded. They had to be canceled, with funds returned because the states couldn’t keep up with cost increases of its own colleges. Others needed to raise costs substantially and add new fees.
3. Saving money in your child’s name
Decades ago, this was a good idea when parents were in high tax brackets and kids were in 0% brackets. But with that loophole closed, the strategy doesn’t work so well anymore for a couple of reasons.
First, at age 18 the assets in the account must be turned over to the child, who may then spend it on a car, an expensive trip or something else other than college.
Second, a family whose child has significant assets is less likely to qualify for college financial aid. Under federal financial aid rules, putting the account in the parents’ names will increase the family’s eligibility for financial support.
So what is the best way to save for college?
We have long advocated for 529 college savings plans established by each state. Here are some of the reasons we think this is the best strategy:
- All the profits earned in a 529 account grow tax-deferred.
- When you need to make withdrawals for college, they are tax-free.
- Some states offer a tax break for your contributions to a 529 college savings plan.
- The money can be used for virtually all college expenses – not just for tuition, room and board, but also for computers and books.
- You can use the funds for virtually any accredited college in the country.
- If a child doesn’t use all the money in the 529 account, you can direct any remaining funds to another child in the family, or a parent, grandparent, sibling or cousin.
- Once you open the 529 account, anyone can contribute to it. This way, grandparents don’t have to open their own 529 savings plan but can just add money to the one you have.
An Edelman Financial Engines advisor can provide additional details and will be happy to show you how a 529 college savings plan may fit into your comprehensive financial plan.