Pros and Cons of College-Payment Strategies

Portrait of a male graduate holding out a diploma

Good Information for Graduates

College students who borrow for school graduate with a debt load equivalent to a new-car purchase or a down payment on a house, averaging $25,000.

Some borrowing might be inevitable. To keep it to a minimum, explore the features of other college payment strategies.

529 savings plans

Pros: Your savings grow tax-free and earnings escape federal tax if you use withdrawals for qualified college expenses. Your state might give you a tax break for contributions. You may invest in other states’ 529 plans.

Cons: If you use the money for noncollege expenses you’ll have to pay taxes and a penalty on earnings. A state-appointed firm manages the account you so lose direct control.

Prepaid tuition plans

Pros: You can lock in tuition at in-state public colleges years in advance. The tax benefits are the same as for a 529 savings plan. If your student goes to an out-of-state or private school instead, you can transfer the value of the account or get a refund.

Cons: Not all states participate. If you use the money for noncollege expenses you’ll have to pay taxes and a penalty on earnings.

Coverdell education savings accounts

Pros: The tax benefits are the same as for a 529 savings plan, and Coverdells expand the definition of “qualified” to include tuition at private elementary schools and high schools.

Cons: Your contributions can’t exceed $2,000 a year and the beneficiary must be younger than 18; contributions are limited by your modified adjusted gross income.

Roth IRAs

Pros: The money in a Roth grows tax-free. Withdrawals are not limited to qualified education expenses. You can avoid taxes on withdrawals as long as they don’t exceed your contributions. You can avoid a 10% early withdrawal penalty on earnings if you use the money for educational expenses.

Cons: If you are younger than age 59 ½, you will owe tax on any earnings you withdraw. If you are 59 ½ or older you must have held the account for five years to avoid taxes on earnings you withdraw. The ability to contribute to a Roth IRA is governed by modified adjusted gross income limits.

Custodial accounts

Pros: You manage the account until the child reaches 18 or 21, depending on your state. After that your adult child owns the account (this could be a con).

There are no limits on how the money can be used. There’s no limit on how much a parent can put into a custodial account.

Full-time students younger than age 24 pay no tax on the first $950 of unearned income and pay the child’s rate on the next $950. Earnings above $1,900 are taxed at the parents’ marginal rate. Investment choices aren’t restricted.

Cons: If your contributions surpass $13,000 a year you’ll have to pay a gift tax. Large balances in a custodial account can hurt chances for financial aid.

Private scholarships

Pros: The money is free and many scholarships are awarded to students based on need or special interests.

Cons: Schools might reduce aid if scholarships and aid combined are more than a student’s calculated need.

With soaring tuition costs, borrowing is often necessary even after accounting for savings and scholarship money. Investigate government-sponsored loans, federal work-study programs, state programs, and institutional aid with the Free Application for Federal Student Aid (FAFSA) form.

Consider federal PLUS loans as well as a private loan from your credit union. Private student loans come into play after all other resources are exhausted.

Whether college expenses are in the distant future or weighing you down today, the professionals at Hopewell Federal Credit Union can help you figure out the best savings strategy to avoid negative tax consequences and the best loan options when all other sources are exhausted.


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