Saving for college: A guide to education funding

Getting ready for college—either for yourself or a child—includes a long list of to-dos. From campus visits and applications to financial aid and budgeting for expenses, breaking these tasks into manageable steps can save you money—and stress—in the long-run.

Understand the costs

A college education can be quite expensive. It’s important to understand the true cost of higher education and how much you can afford.

The total cost to attend a particular school—tuition, fees, room, board, books and supplies, and transportation—can be quite intimidating. But financial aid in the form of scholarships, grants, waivers, and commuting and tuition discounts can reduce the total cost. To help students and parents understand how much their school of choice will cost, colleges provide online “net-price calculators,” which factor in these considerations.

Saving for college

When determining how to pay for higher education, consider a three-pronged approach. The first funding source is money saved before entering college. The second is financial aid—scholarships, grants, and student loans. And the last source is income earned while the student is in college—like income from the student’s part-time job or income earned by parents (e.g., bonuses or employee stock).

Let’s take a look at some specific college savings vehicles:
 

529 Qualified Tuition Plan

• Investment account that can be used to cover education expenses and grows tax-deferred at the federal (and typically state) level
• After-tax cash contributions on the federal level—some states offer tax incentives
• No limits on contributions based on the contributor’s income
• Typically, very high limits on account funding, but annual contributions in excess of $15,000 per donor per beneficiary can have gift-tax consequences
• Federal (and typically state) tax-free distribution for qualified post-secondary education expenses
• Up to $10,000 per year can be distributed tax-free for elementary or secondary, public, private or religious school tuition—state rules can differ
• Investment options limited to those offered by the plan
   

Custodial Accounts (Uniform Gift to Minors Act (UGMA) Account or Uniform Transfer to Minors Act (UTMA) Account)

• Non-deductible investment account held on behalf of a minor
• An irrevocable gift to the beneficiary—considered the child’s asset
• Legal transfer of ownership at age of majority—age 18 or 21
• Funds can be used at any time for the benefit of the child
• Subject to “Kiddie Tax” rules—interest, dividends and other unearned income totaling more than $2,200 may be subject to income tax at the parents’ rates
   

Roth IRA

• Individual retirement account funded with after-tax contributions
• Can access the money you contribute at any time with no tax penalty
• Any earnings gained on your contributions grow tax-deferred and are tax-free upon qualified withdrawal—early withdrawals are subject to income tax plus a 10% tax penalty
• No 10% tax penalty on earnings if used for qualified education expenses
   

Coverdell Education Savings Account

• Tax-deferred savings investment vehicle that allows tax-free withdrawals to pay for qualified education expenses
• Non-deductible contributions of up to $2,000 per beneficiary, per year—contributions can be made until the child turns 18
• Funds must be distributed before age 30—unless the child has special needs or the beneficiary is changed to a younger family member
• Ability to contribute can be limited based on contributor’s income
• Flexible investment options

If you have access to Ayco through your employer, contact an Ayco coach for more information on how you can use these vehicles to save for higher education.
 

Financial aid can help

College education expenses can become a large part of your budget, alongside other major financial expenses—like a mortgage, paying off debt or retirement savings. Financial aid, offered through the government or a school, can help you keep your overall budget in balance.

Financial aid is calculated based on the available assets and income of the student and their family, taking into account the number of family members and number of children in college.

When determining a family’s eligibility for financial aid, the student’s income and assets have a greater impact than those of the parents. The federal financial aid methodology takes into account roughly 50% of a student’s available income and 20% of assets in their name, as compared to 22–47% of parents’ income and up to 5.64% of counted assets owned by the parents. Not all assets count toward the financial aid application process. If Ayco is provided through your employer, speak with a coach to determine which assets have an impact on financial-aid eligibility.

Whether or not you feel your student will qualify for financial aid, it doesn’t hurt to apply. There’s no cost for filing the federal financial aid application.

Determine your budget

How much should you save? There is no one-size-fits-all answer.

When deciding how much to save, parents should consider all of their financial goals, including retirement. Work with an Ayco coach to analyze your budget and see how much you can save while also making progress on your other financial goals.

Worried about student loans? You’re not alone. As of 2020, 45 million borrowers collectively owe nearly $1.6 trillion in student loan debt in the U.S.¹ There’s a reason so many people turn to them—they can be an effective way to fund an education.

For more information on student loans, check out our loan eBook, Lending a Hand.

It is important to consider all of your options. There are many funding sources for higher education. The key here is to focus on how much you can save rather than how much you can’t.

There's a lot to think about. If you have access to Ayco through your employer, connect with a coach to review your options and consider how education funding fits into your overall financial plan.