Three clever strategies to fund your child's education
Bills to pay, retirements to be funded, big purchases to be saved for: The financial demands most families face can make saving for a child鈥檚 college education seem overwhelming or even unattainable. But with some planning,聽it doesn鈥檛 have to be.
Here are three flexible strategies that can help you save for college.
Speed up 529 plan contributions
Most people have heard of . You contribute after-tax dollars to the account, and the money grows and can be withdrawn tax-free, provided it鈥檚 used for qualifying educational expenses. The plans also have provisions that help you聽boost college savings.
Any contribution you make into a聽529 plan counts against your $14,000 annual gift tax exclusion. If you put $15,000 into your daughter鈥檚 529 plan, the first $14,000 would be a tax-free gift, and the extra $1,000 would be subject to gift tax.
However, you can front-load five years鈥� worth of contributions into a 529 without being subject to gift tax.聽That means you can contribute $70,000 in one year 鈥� though you will max out your gift-tax exclusion for the next five years.
Putting $70,000 into the account at once gives聽that money more time to grow tax-free. And you can always withdraw your contributions聽without taxes or penalties. If you withdraw earnings and use them for non-college-related expenses, however, you鈥檒l pay taxes and聽a 10% penalty.
You might also want to tell your parents or your spouse鈥檚 parents about this lump-sum provision. If they鈥檙e planning their estates and looking for ways to divest, they can take advantage of the 529 plan option.
Turn your Roth IRA into a double agent
Many parents believe that saving for retirement and college need to happen separately, but this isn鈥檛 true. If you鈥檙e able to contribute to a , you can save for retirement and college at the same time.
Because you make聽聽with after-tax dollars, you can withdraw them聽at any time without taxes or penalties, just like 529 plan contributions. You only have to worry about paying when you withdraw earnings.
This strategy鈥檚 biggest advantage is聽flexibility. You can choose your聽investments and retain聽control of how the money is used. If your child skips college, you keep the funds聽for retirement.
Another major benefit is that money inside a retirement account, such as a Roth IRA, doesn鈥檛聽count against your child for 聽purposes. This could help him or her聽receive more help paying for college. Money inside a 529 account held in a parent鈥檚 name, on the other hand, does typically count against financial aid awards.
Tap home equity to consolidate high-interest student loans
It鈥檚 hard to avoid borrowing for college expenses, no matter how wealthy you are. In fact, more than 70% of bachelor鈥檚 degree recipients graduate with debt, according to .
Some student loans allow you or your child to defer interest and payments until after聽graduation. But when interest does kick in, the rates can be pretty high. It鈥檚 not unheard of for private loans to charge 9%.
Home equity has increased for a lot of homeowners at the same time student loan debt has reached all-time highs. Meanwhile, have remained near all-time lows for the past few years.
To help your child pay off student loans faster, you could use聽a 鈥渃ash-out鈥� 聽to tap into your equity. This would enable you to consolidate the high-interest student loan to a lower interest rate.
When you execute a cash-out refinance, avoid triggering private mortgage insurance. This occurs when your equity represents less than 20% of your home鈥檚聽value 鈥� or, to put it another way, when your loan-to-value ratio is more than 80%. Lenders require PMI to protect against defaults, and it鈥檚 not cheap. It can cost up to 1% of your loan value every year, or聽$3,000 per year on a $300,000 mortgage.
The average 2014 graduate left college with $29,400 in student loan debt, according to the White House data. If your home is worth $400,000 and you have a mortgage of $250,000, you could do a cash-out refinance to pay off the student loan.聽Here鈥檚 the math:
(Current Mortgage Balance $250,000) + (Student Loan $29,400) / (Home Value $400,000) = 69.85% Loan to Value
In this case, you could pay off the student loan with a cash-out refinance聽and avoid triggering private mortgage insurance. With under 4%, this move could save your child a significant amount of money.
A college education is still within reach, but it takes a mixture of savings, financial aid and smart borrowing decisions to make it affordable. Ask聽your financial advisor about these strategies to determine what makes sense for you.
is a personal finance expert at , a mortgage refinance site based in San Francisco. This article first appeared at . Learn more about Chris on NerdWallet鈥檚 .
