How to plan for your child's largest expense: College
Planning for various expenses as your child gets older, such as food, clothes, and extracurricular activities is a necessary step to take to ensure you are financially prepared to support your children through their childhood. However, planning for college fees is often neglected or the planning starts too late in an individual’s life. At Vantage Point Financial, we believe that planning for your child’s college tuition is a priority, and thus, have outlined various tips to help you start planning for your child’s college fees and expenses.
TAKE ADVANTAGE OF EDUCATIONAL TAX BREAKS
First, saving for college is made easier by establishing special savings accounts: 529 college savings plan or Coverdell Education Savings Accounts (ESA). Both these plans allow you to earn interest on the money you put in, without facing any taxation on interest earned, unlike a regular savings account. Hence, families can save thousands of dollars with these tax-breaks. However, the primary difference between the two saving plans is that a 529 plan can only be used for tuition purposes, while a Coverdell ESA allows you to pay for college/school related expenses as well. Furthermore, families can apply for tax credits, such as The American Opportunity Tax Credit. This is open to individuals with adjusted gross incomes of $90,000 or less ($180,000 if married filing jointly) and can provide up to $2,500 per student annually. Another tax credit is The Lifetime Learning Tax Credit, which pays up to 20% of the first $10,000 in higher education costs.
MINIMIZE YOUR EXPECTED FAMILY CONTRIBUTION
Many families also do not minimize the Expected Family Contribution (EFC), which can affect your child’s eligibility for financial aid, if applicable. The EFC is the portion of your overall family’s income and assets that will be used for spending purposes during the year before you are expected to receive financial aid. Ultimately, this figure is significant for the Free Application for Federal Student Aid (FAFSA), in order to determine your child’s eligibility for financial aid. In order to avoid any confusion, it is essential to ensure all savings accounts under your child’s name are titled properly so that there is no confusion between the parents and child’s assets.
DO NOT IGNORE THE SHORT TIME HORIZON
Moreover, many families underestimate the amount of planning they must do for such a short period of time. Most college savings accounts are used between two to four years, which essentially leaves little room for error or for riding out cyclical changes in the economy. Therefore, it is important to ensure that any investment, savings or other accounts you may have must be re-structured according to the time horizon for various money needs, in this case college. Working with your financial advisor to prepare and restructure your accounts based on the time horizon is vital, even if your child’s college isn’t for another eighteen years.
DO NOT UNDERESTIMATE THE EFFECTS OF INFLATION
While planning for college costs, it is essential to take into account the rise of living costs, which increase around 2% annually. However, college costs usually increase 5%-6% each year, which means that college costs are rising approximately three times as fast as other living costs. As a result, it is important to include these inflation projections in your plan, to ensure that you have saved enough for future expenses.
SEPARATE YOUR RETIRMENET FUNDS AND EDUCATIONAL SAVINGS ACCOUNT
A common mistake amongst parents who are trying to plan for college expenses is that they use their existing retirement funds to pay for college. Many parents make the mistake of taking distributions or loans from their company’s 401k or other retirement accounts and fail to save into their 401ks or IRAs during their child’s college years. This can leave an extremely short amount of time to make up any depleted funds before retirement. On average, borrowing against your retirement can postpone it for 5-10 years.
Taking all these factors into account, we highly recommend planning for future college expenses early, in order to reduce risk posed by a rise in inflation, taxation, retirement fundamentals, and financial aid eligibility.