- Save every month for your kid’s college tuition.
- Decide if a 529, IRA, or Roth IRA is the best vehicle for you.
- Always consider the consequences of putting college savings before retirement savings.
We’ve all watched in dismay as the price of a college education skyrockets in the US, and it’s reached a point where many Millennials are drowning in college debt, and new parents aren’t able to help their kids financially as much as they’d like throughout school. With student loans, financial aid, and 529’s to consider, college planning is tricky to navigate — at least without the proper assistance and knowledge.
At Personal Capital, our advisors get lots of questions about how to tackle paying for college, or paying off student loans, the right way. So today I’ll guide you through some of the most common concerns our advisory team gets, and we hope you’ll give us a call if you have any others.
Read on for the answers to your top 5 financial questions about student loans and paying for college:
1. How much should I save for my child’s education?
The cost of college tuition has risen nearly 6% above the rate of inflation over the past few decades. If you’re a parent saving for your child’s college – you won’t be the first person who’s wondering how you’ll ever afford it. The sooner you make a plan, the better.
Not sure what number to put in your plan? A good “average” tuition cost to aim for is $25,000 per year for public schools, and $40,000 per year for private schools. If you have a baby or toddler and you’re saving with a 529, shoot for funding roughly 30% of the expected cost upfront (if you have the funds available). $28,000 is a good starting amount, since that will keep you under the annual gifting limit (gifting limits are $14,000 per person per giftee, $28,000 for a married couple per giftee). You have the option to add more without a penalty, but it complicates your tax situation. If you don’t have $28,000 upfront, start by contributing $250 per month to a 529 account (assuming you have a young child who will be going to a public university).
As your baby or toddler turns into a young child, fund 50-70% of the 529. You’ll want to continue increasing that percentage as your child ages, just keep in mind that there are penalties for overfunding a 529, which I’ll get into later. The chart below will give you a helpful reference for how much you should have in your child’s 529 by age:
2. What if I overfund my 529, or my child does not go to college?
Unfortunately, overfunding a 529 plan does come with a penalty. Any earnings are taxed as ordinary income–with an extra 10% tacked on. The principal is returned with no penalty. You can leave assets in your 529 indefinitely and use them to fund the education of other relatives. Many plans will even allow you to transfer plan ownership to another person, who might have a lower marginal tax rate depending on how they’re using the assets.
As a parent, you should also think about the variety of paths that your children may take. They might get a scholarship, go to community college for a year, or opt out of college all together (roughly 30% of students opt out). If your child does get a scholarship, you’re allowed to pull the equal amount of money out of your 529 without a penalty. And while the money is in your account, assets can be switched from one child to another, so accounts between multiple kids don’t need to be proportional! That way if one child decides to skip college, you can move around your assets until the money is withdrawn.
3. Should I prioritize student loan debt, my mortgage, or paying off credit card debt?
Unfortunately, there is no black and white solution here. The best plan for you will vary depending on your life stage, level of debt, and other factors, so it can be helpful to talk to a financial advisor who can tailor a solution for you. But here are a few helpful ways to think about it:
•Overall asset allocation is the top factor in determining whether you should prioritize paying down debt. If you’re still in your working years, bear in mind that stocks should take up at least 35% of your net worth. The other key factor is your interest rate – if your after-tax interest rate is higher than or at least close to expected investment returns, focus on paying down your debt aggressively.
•Mortgage debt is generally tax deductible, while unfortunately, most other debt (with the exception of student loans for certain incomes) is not. As a more general rule, if your debt interest is 3-4% higher than the 10-year treasury rate, paying it down is most likely the way to go.
•You should avoid holding low-yielding cash or treasuries while maintaining a high-yielding debt balance, unless you plan to deploy the cash in the near future.
4. How should I prioritize saving for college against saving for retirement?
College savings are obviously important. But if you’re confident that your child will attend college, max out any retirement account options – such as a 401k or IRA – before you fund a 529. The tax deduction and long deferred growth of retirement accounts tends to outweigh the tax-free growth in your 529 for a shorter time period.
If you’re eligible for a Roth IRA, contribute to that account before a 529. The principal can be pulled anytime – including for college. A Roth IRA offers increased flexibility for people who would like to be able to fund college costs if necessary, but aren’t positive they’ll need to do it.
It is imperative to understand the importance of prioritizing your own retirement over paying for college. You can get a student loan for college if need be, but there’s no loan to take out for your retirement if your savings fall short.
5. How should I select a 529 plan?
If you live in a state that provides a tax deduction for 529 plans, finding a plan in your state likely makes the most sense. If not, costs matter. FinAid has some handy resources to help you review your state tax benefits – check it out here.
Planning For College And Paying Off Student Loans
Student loans and college savings are one of life’s largest financial hurdles. Arm yourself with a few of these best practices for savings and paying off debt, and remember you’re not the only one who is struggling through this challenge. Have more questions? Schedule a free consultation with one of our advisors today.
Gregory DePalma, CFP®
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