5 Clever Ways to Save for College That Don't Involve a 529 Plan
According to the National Center for Education Statistics, in 1974, the average total cost for college tuition, room, board, and fees for graduates of four-year institutions was $2,187. As of 2019, that number was a staggering $28,123.
The fear of college expenses is enough to keep plenty parents up at night. And while it's still anyone's guess how much more costs could possibly rise over the next 10 to 20 years, today's families shouldn't simply wait around to find out. Proactive parents, college admissions insiders, and tax preparers have some clever college-savings strategies—that don't involve a traditional 529 college saving or prepaid tuition plan. Here are five favorites.
Former dean of college admissions, now research analyst at Credit Donkey, Ronald Samson tells Parents that "college-savvy parents and grandparents know that 529 plans won't earn enough interest to keep up with rising tuition rates as time goes by. So, they save the bulk of the amount they'd otherwise put into 529s and use the earnings from investments to pay for at least part of their children's college costs."
The risk of doubling down on investments, of course, is that there are no guaranteed gains. Samson suggests that parents of kids heading to college in the next few years consider a Coverdell Education Savings Account (ESA). These accounts used to be called the Education IRA, but they function similarly to 529 plans. ESAs offer tax-free growth and tax-free withdrawals for qualified education expenses. Individuals can contribute up to $2,000 per year, and married couples filing jointly can double that to $4,000 annually.
Samson clarifies that "a Coverdell ESA allows you to invest in a child's education the same way you would invest in your own retirement fund. And, thanks to the recession, you can actually contribute quite a bit per year after taxes. Start an account at any time, but remember that any earnings you make on contributions will be taxed when you withdraw."
In comparison with crypto and stocks, certificates of deposit and bonds can feel painfully boring. After all, they grow slowly, and they are predictably mundane, down to the penny. However, true to the fable of the tortoise and the hare, slow and steady bonds can indeed win the race to college graduation—even if the entire journey feels as slow as molasses.
Carol Tompkins, a business development consultant at AccountsPortal, tells Parents that the ideal is to "set up a bond ladder with one set of bonds that mature just before your child enters college, and another set that matures before or during their sophomore year, and so on." Effectively, parents choose a stable corporate, government, or municipal bond that has a predictable interest rate and a defined maturation date. Instead of buying in bulk, Tompkins suggests staggering the maturation dates so that the funds will become available each year, just in time to pay those tuition bills.
Many parents and grandparents prefer fixed-income assets that exude control and peace of mind. Since no one knows how much college might cost in the future, the general rule of thumb is to calculate gains to cover at least $50k in annual expenses for each year that your not-so-little one is in college or graduate school.
If real estate is already your investment of choice, there are many ways to use property to finance Junior's education. There are a variety of strategies that could work well. The first option is to buy a rental property when your kid is just a toddler and sign up for a 15-year mortgage (or just pay off your 30-year mortgage in 15). By the time the mortgage is fully paid, the cash flow might float the entire cost of education year on year.
Erik Wright, owner of New Horizon Home Buyers in Chattanooga, Tennessee, explains to Parents that this way, "not only is the house paid for by the time they are ready to go to college, but if you set aside the profit from the rental income each month, that's almost two decades of passive income for college or whatever your child is aspiring to do."
The second option is not to keep the place rented but to sell it and fork over the proceeds to cover university costs. This could work well if appreciation is on your side and you've got a plan to minimize capital gains taxes.
The third option—of an infinite number of others—would be to situate your purchase in the heart of a town where your kid is likely to study. This is hard to predict, but it may be easier to forecast if your family has a legacy of attending the same school or staying in a particular location. The benefit of this approach is that it ensures that your kid could live rent-free in a mortgage-free house—and there's no need to worry about dormitories or meal plans. If the place is a multi-unit, even better; your kiddo can act as the property manager, actually earning their room and board, all while helping you recruit the right kind of student-tenant who won't trash the place.
Gifts from Grandparents
Grandparents aren't just the best babysitters in the world; they can also be trusted allies in a holistic plan to pay for their grandkids' college experience. Many are willing and interested, but just don't know how. Jack Schacht, the founder of MyCollegePlanningTeam.com, works with many inter-generational families in the Chicago area. He tells Parents that grandparents should make their intended financial contribution known so that the entire family can coordinate funding together.
The upside to using grandparents' funds is that their accounts are not considered "family income" for the purpose of determining financial aid eligibility through the FAFSA (Free Application for Federal Student Aid). However, parents' assets and income—as well as balances in custodial bank accounts for kids—are considered in that determination. Thus, any savings among the nuclear family can be used to raise the EFC (Expected Family Contribution) and to diminish scholarships, grants, or on-campus work.
Before grandparents write a big check, Schacht warns: "Avoid financial perils and pitfalls. A monetary gift to your grandchild may result in a tax event on your end or interfere with financial aid eligibility on theirs. For example, according to IRS guidelines on gift exclusions, you can give up to $15,000 a year to your child or grandchild without paying gift tax. However, that monetary gift to your grandchild may reduce his or her taxable income."
What if you want to send the check to the college directly? Schacht says that "the IRS may not count it as a gift. Depending on the college, your payment may negatively impact the student's eligibility for aid." It is best to work with a financial planner and the college's financial aid office to figure out the best way to carry out a contribution without harming anyone involved.
Put 'em on the Payroll
"Small business owners hoping to pay for their kids' college tuition can hire them as an employee of the business and set their annual salary to an amount that would pay for, or help offset, a year of tuition," Doug Jackson of Tennessee Tax Solutions explains to Parents. "This would give the child money for their future tuition while teaching them the value of hard work. The parent/business owner would also be able to take a tax deduction for the salary paid out to the child, as long as the role is a bonafide position in the company and the child performs a commensurate amount of work to justify their income."
Sound too good to be true? Well, Jackson has a decade of financial industry experience, is a Certified Financial Professional, and is an enrolled agent with the IRS. His strategy is solid.
Lynn Richardson explains to Parents that there are a number of financial education tools to help parents set up viable small businesses that employ their children. The key to making this work is not just forking over money that your kid didn't earn. First, you have to have a legally established small business. Second, the kid must have a real position, with age-appropriate responsibilities. In exchange for their work, they get paid a reasonable amount for their labor (you can benchmark "reasonable" by comparing how much other companies pay people in similar roles or how much it would cost to hire a contractor to do it instead).
Generally, if your kid is getting paid at or slightly below market rate for their work, then the IRS rules on employing family members make this a mutually beneficial arrangement for the both of you. Employing your child will not only teach them work ethic, but it can be combined with the strategies above—real estate management, in particular—to lock in those college savings.