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How To Save and Invest Money For College

This article was written by Gary Dek, a finance blogger who writes about making money, investing, budgeting, career and education planning, credit and debt, and real estate at Gajizmo.com. Gary previously worked for an internet company on their M&A team, as well as investment banking and private equity firms in California. He graduated USC with a degree in financial analysis, valuation and entrepreneurship.

The competition for college scholarships and grants is fierce and even students with excellent grades are no longer guaranteed to receive academic and need-based financial assistance for college. Student loans have never been easier to obtain, but they can mean starting out in adult life with crippling debt. Careful planning by parents can help students get their degree without financing all or even most of their tuition and other costs.

The cost of college tuition is rising at nearly twice the national rate of inflation. The average education costs at private colleges last year was $38,589, while resident students attending state colleges paid about $17,000 per year. Out of state students attending state institutions paid about $29,657 per year for tuition, and these figures do not include living expenses like dormitory fees or food. Books and supplies for college classes add a significant amount to tuition and other costs.

If you are looking for unique ways to fund your child’s college education, you should try making money from home or growing your side-business. The benefit of running your own business while sending your child to college is that you can decide how much of a salary to pay yourself each year, which can increase the amount of financial aid you receive. Since your income is treated differently than your assets (the value of your business, so be conservative with your estimate), a lower income with higher unrealized asset gains can make college more affordable for your family. Otherwise, if owning a business is not an option, stick to these traditional ways of saving and investing money for college.

529 Custodial Accounts

A 529 account is owned by the parent with the child as beneficiary. The money in these accounts can only be used for educational expenses so it is important to start the account with a target figure in mind. Withdrawing funds for non-educational expenses costs a stiff 10% penalty, but the beneficiary on the account can be changed to another child or relative if there is extra money in the account, or if the child opts not to attend college. Additionally, investment gains in the account are tax-free, allowing your money to grow uninterrupted by capital gains or income taxes.

Since there is a penalty for withdrawal of funds for non-educational purposes, it is best not to over-invest in a 529 account, but other investments can be used to complement this savings plan and ensure there is enough money to cover a child’s educational expenses.

Life Insurance

There are several types of life insurance policies that accrue cash value over the years. An endowment policy, purchased in infancy will usually mature in 20 years and pay out a cash payment stated in the policy. Whole life insurance offers the option of taking out interest free loans of up to 90% of the cash value, with no repayment schedule, while keeping the policy in force. These policies also allow young people to have the lowest life insurance premiums for life since whole life is a permanent type of coverage. No income tax is due on loans taken on permanent policies.

People with a slightly higher tolerance for risk may choose a universal life insurance policy. While whole life insurance is invested conservatively and offers a guaranteed rate of interest, similar to other short term investment options, universal life policies utilize riskier investments like stocks and bonds and may yield a higher rate of return over time. Life policies can be set up so beneficiaries receive the face value of the policy minus loans if you should die or the face value plus any remaining equity.

The premiums on permanent policies are considerably higher than those of term life policies so it is best to use these policies as an alternative investment vehicle. Instead of buying all your life insurance in a permanent policy, supplement permanent coverage with cheaper term protection.

Fixed Annuities

A fixed annuity can be a way to save for college tuition if you will be at least 59½ years old while your child is attending college, since penalties for early withdrawal no longer apply. Otherwise, fixed annuities are retirement accounts that have high penalties for early withdrawal. While they are not the best and most recommended way to save for your children’s college, they do have tax advantages over other types of retirement savings. The money invested in fixed annuities and any returns earned on these funds cannot be considered as assets by lenders offering government approved student loans. This means you can keep your retirement funds while qualifying for federal financial aid, including grants and very cheap or subsidized loans.

Nevertheless, sending your child to college should not jeopardize your retirement so it is best to use this type of investment as a retirement account rather than saving for college, unless the two coincide. After all, when you pass 59 ½ and are not within the surrender period of 5 to 7 years after issuance, the annuity begins to pay out an income stream. With that income stream, you are free to do as you please.

Roth IRAs and 401(k)s

Roth accounts differ from traditional retirement savings plans because contributions to Roth accounts are not tax deductible. Income tax is paid on the money before it is put into savings. While the contributions are not tax deductible, you can withdraw contributions, for any reason, without paying a penalty since the money has already been taxed. There is a 10% early withdrawal penalty on investment returns, but this does not apply if the money is withdrawn for qualified educational purposes, including tuition payments. If the returns on your contributions are equal to or greater than the total contributions to your account, you may have to pay a penalty if you withdraw the earnings that exceed the amount of your contribution. Beyond that, Roth IRAs and retirement accounts can be a legitimate source of money for education costs.

Treasury Bonds

Treasury Bonds can be an excellent savings vehicle for those who are financially conservative. At one time, it was commonplace for grandparents and relatives to give U.S. Savings Bonds as gifts to newborn infants so they would begin their adult lives with a nest egg. Unless you need supplies for your new baby, suggest the gift of a Treasury Bond to those who ask what you need. They are available in denominations that cost less than a new stroller or crib and they take years to mature. When your child is ready for college, the treasury bonds given as baby gifts can help pay a significant portion of your child’s schooling expenses.

Final Word

The average income of a person with a college degree is more than a million dollars higher over a lifetime than the income of a person with a high school diploma. Higher education is necessary for the financial success of your child when he or she reaches adulthood and pursues a career. The average cost of a four year college degree is expected to rise to over $100,000 by the year 2016. The best way to ensure the success of your child is to begin a savings plan at their birth. Professional financial advisors can help parents find and execute the best ways to save and invest for the future of their children.

Check out www.Gajizmo.com to find more of Gary’s writing.

  • Free Money Minute May 14, 2013, 7:29 am

    Although I agree college has the potential to earn you more money over your lifetime, it is not an option for everyone. Some people would benefit from going into a trade (electrician, plumber, etc) and avoiding the crippling debt (I like the way you put this) or student loan debt. I would encourage people to take a step back and see what they want out of life before simply going through the process of signing loans and going to class.

  • Gary@Gajizmo.com May 14, 2013, 4:12 pm

    FMM – Completely agree. If the kids decide they don’t want to go to college because they’d rather pursue a trade, no problem. I’d use the money to help them follow through on their decision and get started rather than waste $100,000 just to have a college diploma for the sake of it. That is a lot of money to “waste” in a situation where it won’t be appreciated.

  • Honolulu Aunty May 14, 2013, 7:48 pm

    That was great GaryatGajizmo.com!

    I am glad our 4 kids are finally out of college – don’t know how we did it. Now we are tuition free – what a fantastic feeling!

    I wish I had done at least 1 of the strategies that you recommended. I thought the only option we had was the 529 custodial accounts – but they were so limited and not a great way to appreciate funds, imo.

    The key to all this is to start EARLY when the keikis (kids) are young. But I also think that we must take care of our own retirement needs first. We used to tell our kids that they could go to the mainland college of their choice and we would pay, but if we can’t afford it, they would have to find a cheaper college or transfer to the University of Hawaii as a resident.

    Another strategy that I heard was from Phill Grove, a real estate investor. He and his wife bought a single family house at a good price in the name of their son’s trust when he was just born. With rental income and the appreciation by the time the kid was college bound, his college education would be covered.

    Mahalo for your wisdom,


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