Paying for College (Part 1): Overview of College Funding Options
Paying for college can be challenging for even the most well-off.
Costs have more than doubled in the 21st century and continue to rise by an average of 7.1% per year. The average annual cost of college in the United States for the 2022-23 academic year, including books, supplies and daily living expenses, was $36,436 for public schools. The average private university cost over 50% more than that: $55,840. And considering lost income and loan interest, the ultimate price of a bachelor’s degree may be as high as $509,000. *
There are multiple puzzles to solve beyond affordability in the college funding process. How do you choose the right funding plan for your situation? How much should you save? What happens if you end up overfunding it?
In this first installment of our mini-series, we provide an overview of the college funding solutions we recommend and give some pros and cons in the capsule summaries that follow. A second article and accompanying video will cover 529 plans in greater detail.
Funding Options
Financial Aid
The Free Application for Federal Student Aid (FAFSA) is the form students need to fill out to get any financial aid from the federal government. Despite a widespread misconception, it is possible to obtain assistance even if your family has an income of over $200,000 a year. To get an idea how much aid you could receive, the Federal Student Aid Estimator at https://studentaid.gov/aid-estimator/ can provide an early estimate of your Expected Family Contribution and eligibility. If you are just interested in obtaining an unsubsidized (non-need-based) loan for your student, submission of the FAFSA is required. The FAFSA is available at https://studentaid.gov and is free to submit. The annual filing deadline is June 30. States and colleges have their own FAFSA deadlines, too, so it’s important to check the deadline for each college you apply to. Students also can apply for scholarships and grants based on financial, academic and athletic ability.
529 Plans
A 529 plan is an investment account offering tax benefits when used to pay for qualified education expenses for a designated beneficiary. These plans are widely considered to be the best way to save for college. You can use withdrawals from a 529 plan to pay for college, K-12 tuition (in some states), certain apprenticeship programs and student loan repayments.
PROS: Take advantage of market growth to subsidize education costs; numerous investment options; significant tax advantages (accounts grow tax-deferred, distributions are tax-free if used to pay for qualified education expenses, and some states offer income tax deductions on contributions); good way to remove assets out of estate while retaining asset control (student cannot use account without owner); low fee options; peace of mind derived from designating and funding a separate account earmarked for large education expenses.
CONS: Non-qualified withdrawals subject to tax on earnings portion and 10% penalty on withdrawal amount; could reduce financial aid potential; exposure to market risk.
Altair’s financial planning team has much more to say about these plans and can assist with questions about individual situations. Again, part two of this blog series focuses on 529 plans in far greater detail. A good starting point for learning about 529 basics and options online is https://Savingforcollege.com.
Coverdell ESAs
Fund and use Coverdell ESAs (Education Savings Accounts) to fund college expenses.
PROS: Tax-deferred account growth; tax-free withdrawals – more liberal than 529s in determining qualified education expenses; can be used for K-12 expenses; flexible investment options; can be rolled over to 529 plan.
CONS: Strict contribution limits ($2,000 per student); low returns; income restrictions; must be at least 24 years old in the month the bonds were purchased; parent or spouse must own the bond; if owned by grandparent, benefit only available if student is grandparent’s dependent.
UTMAs
Set up or use an existing UTMA (Uniform Transfers to Minors Act) account for child and withdraw funds as needed to fund education costs.
PROS: Simple and flexible – funds can be used for anything; no contribution limits beyond gift tax rules (annual exclusion gifting rules apply); large array of investment options; no penalties on withdrawal.
CONS: Assets are property of the minor. Student can use funds for any purpose and may not use funds for college; kiddie tax – account earnings beyond $2,100 are taxed at trust tax rates; beware of the 3.8% Net Investment Income Tax (NIIT) for high-income families; UTMA assets are viewed as student-owned and increase expected family contribution by 20%; included in guardian’s taxable estate at death; annual tax payments (unlike 529s).
Cash and Taxable Investments
Use existing cash or sell taxable investments and write checks directly to the university on behalf of the student as expenses are incurred.
PROS: Simple and flexible – money can be withdrawn at any time for any purposes; no gift tax consequences on payments made directly to the university (tuition only), thereby leaving annual exclusion amount intact; take advantage of market growth and capital gains treatment (or realize capital losses) on investment sales; retain total control of assets.
CONS: Lose out on tax-deferred growth and tax-free distributions for qualified education expenses by not using a 529 plan; no charitable deduction for the tuition payment; does not take advantage of moving assets outside of taxable estate beyond expenses paid during your lifetime; not earmarking assets for college funding can make large expenses seem more overwhelming.
There are multiple options for covering the costs of higher education. We encourage clients to talk with their client service team about the approach(es) that work best for your family’s situation.
The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice. Although we made efforts to verify the accuracy of the information, Altair Advisers cannot guarantee its accuracy. Please see Altair Advisers’ Form ADV Part 2A and Form CRS at https://altairadvisers.com/disclosures/ for additional information about Altair Advisers’ business practices and identified conflicts.