For many Americans, the beginning of the year is a time to set goals –goals that are often financial. And while getting out of debt, socking away cash for retirement and earning more income are all noble resolutions for 2015, for parents of children near college age and even younger, saving for college is likely at the top of the list.
There are certainly some tried-and-true options to help families save for college, but the new year brings an opportunity to consider some lesser known, but equally effective, strategies. Here are three that experts say more families are turning to.
1. Roth IRAs: Traditionally, Roth IRAs have been used for retirement planning, but Thomas Scanlon, a CPA and certified financial planner based in Manchester, Connecticut, says he has seen parents begin to use those funds for college.
Unlike regular IRAs, contributions to the Roth can be withdrawn tax free. For parents over age 59 1/2, all distributions are tax free as long as the account has been open for at least five years. Meanwhile, parents younger than age 59 1/2 can receive tax-free deductions up to the amount they contributed, and anything above that is considered taxable income.
It’s an attractive option for parents who need to play catch-up on saving, but Scanlon avoids recommending it across the board. "The only possible benefit I could see is if they used the Roth IRA in lieu of borrowing money to pay for college," he says. "I personally don’t see using the Roth IRA to fund college as a smarter financial decision. The intent of the Roth IRA is that it be used for retirement. If is spent on college, it won’t be available for retirement."
Sean Moore, a certified financial planner with SMART College Funding in Boca Raton, Florida, agrees that raiding a parent’s retirement account isn’t a wise plan, but he does advocate for the use of a Roth IRA in the right circumstances – particularly given it is not factored ino federal government's estimation of what a family can pay for college, known as the expected family contribution.
"Many clients don't think 'IRA' when planning for college, but the Roth can be a fantastic vehicle," he says. "For example, if a child is working, he or she can contribute to a Roth IRA. The money inside the Roth will grow tax deferred and will not count against the child for financial aid purposes – if it were in a savings account or regular investment account, 20 percent would count against their EFC. If the money is needed to help pay for college costs, it is available. If it is not needed for college, the child gets to keep the money in the Roth and has effectively started saving for retirement in their teens."
2. Third-party and multi-generational savings: Saving for college can be a daunting endeavor for many families, especially those with more than one child in school. And, as a result, more parents are turning to outside help.
"We are seeing a rise in the number of families whose college savings efforts go beyond the traditional nuclear family unit," says David Macauley, the college planning program manager for Thrivent Financial in Austin, Texas. "Often, this will include 529 plans or other savings vehicles funded by grandparents, non-custodial parents in blended families or divorce situations, as well as other family members that are not within the student’s household as defined on the FAFSA."
The Free Application for Federal Student Aid, otherwise known as the FAFSA, is a form that is completed by students and their parents to determine a student's eligibility for federal financial aid.
In these cases, parents can suggest contributions to a 529 or other savings program in lieu of birthday or Christmas gifts, or offer to match any donation from outside the family. 529 plans are tax-advantaged educational savings accounts that anyone can contribute to, and, with multiple sources contributing, the college financing load will be much lighter all the way around.
But in cases like these, Macauley warns, confusion could arise come tax time. "Parents may want to claim a tax credit, such as the American Opportunity Tax Credit or Lifetime Learning Credit, while a grandparent may want to use the same expense to justify a tax-free distribution from a 529 plan," he says. "The same expense cannot be used to justify more than one tax break, so communication and coordination are necessary."
Macauley also says that any college-related funds that a college-age student receives from someone other than a custodial parent could reduce the amount of eligible financial aid by as much as $.50 on the dollar the following school year. These funds, whether given directly, via cash or check, or disbursed from a 529 plan with third-party investments, count toward the student’s untaxed income.
Those funds must be noted on the FAFSA, and according to federal guidelines, any income above $6,310 will directly impact aid eligibility. Distributions from a custodial parent’s 529 plan are not treated as the student’s income, however, but the funds contained therein do count as part of the parent’s total assets.