I am honored to serve on the University of Tennessee’s board of trustees.
Trust me; we are working very hard to hold down the cost of college tuition. Twenty years ago, the state of Tennessee funded 61 percent of the higher education costs at UT Knoxville. Tuition was 30 percent and outside fundraising was 9 percent. In 2016, the numbers have almost reversed between state funding and tuition. The state now funds 31 percent, tuition funds 63 percent, and private fund- raising 6 percent.
With tuition on the increase across the country, families have to be strategic.
For those who qualify for various types of financial aid, this is generally determined based on income and assets during a child’s junior year of high school. Students with sizable savings in their name could find themselves ineligible for some types of benefits.
The Free Application for Federal Student Aid, or FAFSA, is used to determine the child’s edibility for aid. But please remember, financial aid in the form of loans must still be repaid, albeit often with favorable terms. Better to have saved and be able to use cash for tuition than to take out a loan. I recently met with someone approaching retirement age who still has college loans outstanding. You certainly don’t want to be in that situation.
The good news is there are several ways to prepare for college tuition. Here are our top picks:
529 Savings Plan
This plan offers a variety of investment options for parents to save for a child’s college education tax-free. There are restrictions, but the money can be used for tuition at accredited two- or four-year colleges and universities.
The 529 funds belong to the account owner, typically a parent or grandparent and not the child; therefore, 529 plans in a parent or dependent child’s name are considered parental assets. Only 5.64 percent of parental assets are counted as available for financial aid instead of the 20 percent that applies to student assets. And for future years, distributions (withdrawals) from a parent-owned 529 plan that are used to pay the beneficiary’s qualified education expenses aren’t classified as either parent or student income on the FAFSA.
Prepaid Tuition Plan
The prepaid plan allows parents to pay for tuition credits in advance at a predetermined price. It is designed for those confident their child will attend an in-state public university. This plan retains some of the benefits of the 529 plan but without the volatility of the stock market.
The Uniform Gifts to Minors Act and the Uniform Transfer to Minors Act are options with some tax benefits for the first and second $1,000 in gains, but are taxed at the parent’s income after that. The downside is that parents have less control over how the child eventually spends the money. These accounts are the child’s assets for FAFSA purposes.
While not specifically designed for college savings, this tax-advantaged retirement savings account can be an effective tool. After-tax money is contributed and the owner is allowed to take out funds tax- and penalty-free to pay for qualifying educational expenses after five years. There are still some restrictions based on income, age, etc. These funds would really be great for long-term savings since they accumulate tax-free, not tax deferred.
Opening a trust in the name of your child is how college savings was traditionally done before 529 plans and UGMA/UTMA accounts. They are still viable options, but the funds can be used for more than just college expenses, which could be a pro or a con. Considered the child’s asset for FAFSA, the trust may have an impact on qualifying for other assistance.
The reality of saving for college today may mean more than one vehicle will garner the best results for your particular situation. Regardless, starting early gives you the most flexibility. It often also allows you to involve other family members like grandparents.
While the dream of your child ending his or her education without student loans sounds great, it’s not necessarily a bad idea for your child to have a little skin in the game by paying for some portion of college himself or herself.
It helps them appreciate the value of your effort to support their education.