Strategies for Paying
Several of these approaches, like taking a home equity loan, involve long-term commitments and a level of risk you'll have to consider carefully. But it pays to know about the choices you have, since one of them may just be the solution you're looking for.
GIVING GIFTS TO MINORS
Custodial accounts fall under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfer to Minors Act (UTMA) and are generally known by those acronyms. The major difference is that UTMA contribution rules are more flexible, permitting assets such as real estate and fine art that don't produce regular earnings.
You can contribute as much or as little as you like to an UGMA or UTMA account, though annual gifts over $15,000 (or $30,000 if a married couple filing a joint return makes the gift) are potentially taxable to the giver. You can invest the assets as you see fit. Any income or capital gains tax that may be due each year is figured at the beneficiary's rate once the child is 19, or 24 if a student. For younger children, tax on investment earnings over the exempt amount is figured at their parents' rate.
TAKE A SECOND LOOK
Custodial accounts may work well as college savings plans because you have enormous discretion over how to invest the assets. The more confident you are about choosing a diversified portfolio, the more attractive this approach may seem.
However, UGMAs and UTMAs also have some potential drawbacks.
- If the beneficiary applies for financial aid, she or he will be expected to contribute up to 20% of the balance each year in keeping with the standard formula.
- When the beneficiary reaches majority, she or he has the right to assume control of the account.
- Any earnings are taxable, unlike earnings in a 529 or ESA.
While these accounts guarantee a specific level of return, you may be able to earn more in a diversified portfolio you put together yourself. And interest on the CDs is taxable, unless you own them within a Coverdell education savings account or participating state 529 plan. For more information, go to www.collegesavings.com.
HOME EQUITY LOANS
If you bought your home when your child was small, the original mortgage may be nearly paid off. That makes it easier to arrange an equity loan. And writing a check to the lender every month won't come as such a financial shock since you've been making mortgage payments all along.
Home equity loans are not a perfect solution, though. First, the money has to be paid back, usually starting immediately. And, if for some reason you default, or fail to pay back your loan, you run the very real risk of losing your home.
DEGREES FOR LESS
If you're looking for other ways to save money on college costs, you might consider encouraging your child to consider an accelerated program:
- Some colleges offer credit for high school advanced placement courses, which could mean finishing a degree a semester, or even two, early.
- Credits earned at local colleges during summer school may count toward graduation and can reduce the number of semesters required.
- Some colleges offer three-year programs that move students through their required courses more quickly.
- Two years at a community or junior college before transferring to a four-year college or university will help lower the total cost of a degree.
A BOND DEAL
Because the bonds mature on a specific date, you can time them so you'll have cash on hand every semester or every year. Some of them provide an extra bonus if you use the money to pay tuition at an in-state school. But if you sell these bonds before they mature, you stand a good chance of losing money, as well as depleting funds you'll need for college.
WHAT'S NOT SMART
One of the conflicts you may wrestle with is whether to use the money you've invested for retirement to pay for your child's education. Most financial advisers think it's a bad idea because it may leave you short of income later on. But if it makes the difference between your child's going to school or not, you may consider a loan from your employer's plan — if the plan allows loans — or a withdrawal from your IRA.
The loan isn't income, so there's no tax. But if you leave your job before repaying the full amount, the balance will be considered an early withdrawal, subject to tax and a federal tax penalty if you're younger than 59½.
If you take money from your traditional IRA, you'll owe income tax on the earnings portion of the amount you withdraw and on the contribution portion if you deducted it, though not a prepayment penalty. That's because paying college expenses is considered one of the legitimate reasons for early withdrawal.