Planning For Your Child’s College

College Savings

Starting a savings account in your child’s name can seem like a great idea when they are young. However, it could be a decision that you regret.

Choosing the wrong savings plan now could end up causing them to miss out on thousands of dollars in avoidable taxes and missed financial aid when it comes time to pay for college.

When it comes to determining financial aid, there is an asset protection allowance, or APA, that protects a portion of the parents’ assets. The students’ personal income and savings actually have a bigger and possibly more negative, impact on how much financial aid is available than parental assets and income.

Since the amount of financial aid is established based on the income and assets from the year just before applying for aid, a student with a large amount of savings in their name could end up forfeiting a sizeable sum of free college money.

Fortunately, quite a few ways exist for parents to save that will not put their children’s future financial aid at risk. Here are a couple of places to safely stockpile cash:

529 college plans

A popular way to save for college is by using a 529 college savings plan. These allow parents to put money aside to pay for their child’s higher education, tax-free and offer a few different investment options.

These plans can offer large tax advantages since the gains on the accounts are tax-deferred. When the funds are withdrawn to pay for qualified tuition expenses you will never pay taxes on them.

The money in a 529 college savings plan can be used to pay for undergraduate or graduate studies at any accredited two- or four-year college in the United States.

Although a 529 savings plan can offer some major advantages, they do contain some restrictions. According to the SEC, 529 college savings funds may be withdrawn tax-free only if they are used for qualified education expenses which include tuition, fees, books, supplies, and room and board. Any money that is spent on unqualified expenses is subject to normal income tax plus a 10 percent penalty on all earnings.

Prepaid tuition plans

One alternative that has appealed to some parents is a prepaid tuition plan. These are designed for parents who are positive that their child is going to attend an in-state public university. Under this plan, parents will simply prepay for tuition credits at a predetermined price.

The same tax, financial aid, and parental protections are retained under the prepaid tuition plans as a 529 college savings plans, but without you don’t have to worry about an upset in the stock market.

The major limitation to when it comes to using a prepaid plan is that if your child decides instead to attend an out of state school, they’ll get a return on their investment, but without the full value of the plan. Since these plans are prepaid at a predetermined price it is usually less than what normal tuition increases will be.

Both the 529 college savings plans and the prepaid tuition plans allow for plan holders to change beneficiaries at any time, but you still must pay income tax plus a 10 percent penalty on any funds that are used for anything other than qualified college expenses.

Sometimes it’s even a good idea to combine the two and have the prepaid plan to pay for tuition along with a 529 college savings to pay for other expenses.

Some Common mistakes

Some parents believe that it makes more sense not to have any savings at all for their child’s future. They feel that if you have no college savings it also means that you have no assets to assess. This strategy may not work since even if parents don’t save anything, they will still have an expected contribution once they complete the FAFSA (Free Application for Federal Student Aid) form.

It’s always a good idea to speak with a financial advisor to get all the alternatives and come up with a sound plan that covers both the parents’ retirement first and still put together some sort of savings for the child’s future needs.