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Bills to pay, retirements to be funded, big purchases to be saved for: The financial demands most families face can make saving for a child’s college education seem overwhelming or even unattainable. But with some planning, it doesn’t have to be.
Here are three flexible strategies that can help you save for college.
Speed up 529 plan contributions
Most people have heard of 529 college savings plans. You contribute after-tax dollars to the account, and the money grows and can be withdrawn tax-free, provided it’s used for qualifying educational expenses. The plans also have provisions that help you boost college savings.
Any contribution you make into a 529 plan counts against your $14,000 annual gift tax exclusion. If you put $15,000 into your daughter’s 529 plan, the first $14,000 would be a tax-free gift, and the extra $1,000 would be subject to gift tax.
However, you can front-load five years’ worth of contributions into a 529 without being subject to gift tax. That means you can contribute $70,000 in one year — though you will max out your gift-tax exclusion for the next five years.
Putting $70,000 into the account at once gives that money more time to grow tax-free. And you can always withdraw your contributions without taxes or penalties. If you withdraw earnings and use them for non-college-related expenses, however, you’ll pay taxes and a 10% penalty.
You might also want to tell your parents or your spouse’s parents about this lump-sum provision. If they’re planning their estates and looking for ways to divest, they can take advantage of the 529 plan option.
Turn your Roth IRA into a double agent
Many parents believe that saving for retirement and college need to happen separately, but this isn’t true. If you’re able to contribute to a Roth IRA, you can save for retirement and college at the same time.
Because you make Roth IRA contributions with after-tax dollars, you can withdraw them at any time without taxes or penalties, just like 529 plan contributions. You only have to worry about paying taxes and penalties when you withdraw earnings.
This strategy’s biggest advantage is flexibility. You can choose your investments and retain control of how the money is used. If your child skips college, you keep the funds for retirement.
Another major benefit is that money inside a retirement account, such as a Roth IRA, doesn’t count against your child for financial aid purposes. This could help him or her receive more help paying for college. Money inside a 529 account held in a parent’s name, on the other hand, does typically count against financial aid awards.
Tap home equity to consolidate high-interest student loans
It’s hard to avoid borrowing for college expenses, no matter how wealthy you are. In fact, more than 70% of bachelor’s degree recipients graduate with debt, according to a 2014 White House report.
Some student loans allow you or your child to defer interest and payments until after graduation. But when interest does kick in, the rates can be pretty high. It’s not unheard of for private loans to charge 9%.
Home equity has increased for a lot of homeowners at the same time student loan debt has reached all-time highs. Meanwhile, refinance rates have remained near all-time lows for the past few years.
To help your child pay off student loans faster, you could use a “cash-out” refinance to tap into your equity. This would enable you to consolidate the high-interest student loan to a lower interest rate.
When you execute a cash-out refinance, avoid triggering private mortgage insurance. This occurs when your equity represents less than 20% of your home’s value — or, to put it another way, when your loan-to-value ratio is more than 80%. Lenders require PMI to protect against defaults, and it’s not cheap. It can cost up to 1% of your loan value every year, or $3,000 per year on a $300,000 mortgage.
The average 2014 graduate left college with $29,400 in student loan debt, according to the White House data. If your home is worth $400,000 and you have a mortgage of $250,000, you could do a cash-out refinance to pay off the student loan. Here’s the math:
(Current Mortgage Balance $250,000) + (Student Loan $29,400) / (Home Value $400,000) = 69.85% Loan to Value
In this case, you could pay off the student loan with a cash-out refinance and avoid triggering private mortgage insurance. With current mortgage rates under 4%, this move could save your child a significant amount of money.
A college education is still within reach, but it takes a mixture of savings, financial aid and smart borrowing decisions to make it affordable. Ask your financial advisor about these strategies to determine what makes sense for you.