Strategies For Funding Your Child’s Education Through Evidence-Based Financial Planning

Funding your child's education is one of the most important investments you can make in their future. With the rising costs of higher education, you’ll need to start saving early and explore the various funding options available.

The Cost of Higher Education

The cost of higher education has been on the rise for several years and is expected to continue increasing in the coming years. The rising cost of tuition, room and board, books, and other expenses makes it difficult for many families to afford higher education for their children.

The tuition and fees for a four-year public university for in-state students were $10,662 for the 2023-2024 academic year. Private nonprofit four-year institutions charged an average of $42,162 per year.

State schools may offer other cost-saving benefits in addition to lower tuition rates. Many public universities have partnerships with local businesses and organizations, which can provide students with internships, co-op programs, and other work opportunities. These experiences can help students gain valuable skills and experience while also earning money to help pay for their education.

State schools may also offer more financial aid and scholarship opportunities. Many public universities have large endowments and scholarship funds that they use to help offset the cost of tuition for students in need. State schools often have specific scholarship programs for in-state students or those studying certain majors or fields.

Higher education involves other expenses, like room and board, textbooks, transportation, and personal expenses. These can add up quickly and make higher education unaffordable for many families.

Online Calculators

Online calculators are one way to predict the cost of a child's higher education. These calculators consider factors such as the cost of tuition, room and board, and other expenses, as well as the expected inflation rate and the number of years until the child begins college. With this information, the calculator can estimate the total cost of attendance and help you plan for the future.

Save Early

Saving early for your child's education gives your money more time to grow through the power of compounding.

Assuming an annual return of 6%, if you start saving $250 per month when your child is born, you could accumulate over $90,000 by the time they turn 18. However, if you wait until your child is 10 to start saving, you must contribute nearly $800 monthly to reach approximately the same goal.

Funding Options

You have many options for funding your child’s education. Here are some of the most popular ones.

Scholarships and Grants. Researching scholarships and grants can be a great way to fund your higher education and reduce the burden of student loans. Here are some tips to help you find the right scholarships and grants for you:

Look at your school's financial aid website or office. Most schools offer a variety of scholarships and grants, and they can provide you with information on how to apply.

Use online scholarship search engines. Websites like Fastweb, Scholarships.com, and Appily allow you to create a profile and search for scholarships that match your interests, primary, and other criteria.

Look for scholarships and grants from professional organizations. Many organizations offer scholarships to students pursuing careers in their field. For example, the National Science Foundation provides scholarships to students studying science, technology, engineering, and math (STEM) fields.

Check with your community. Many local organizations, like community foundations, service clubs, or non-profits, offer scholarships to students in their area.

Talk to your high school guidance counselor. They may have information on scholarships and grants available to students in your area or through national programs.

Consider applying for federal grants such as the Pell Grant. You can apply for federal aid by submitting the Free Application for Federal Student Aid (FAFSA) each year.

Read the eligibility requirements carefully and apply for as many scholarships and grants as possible.

Student Loans. Student loans can be a viable option for funding higher education but approach this option with caution and careful planning. Here are some tips to help you use student loans responsibly:

Understand the different types of student loans: There are two main types: federal and private. The government backs federal student loans and generally offers more favorable terms and repayment options. Banks and other financial institutions issue private student loans, which may have higher interest rates and stricter repayment terms.

Only borrow what you need: Only borrow what you need to cover your education expenses. Don't take out more than necessary, as this will only increase your debt burden in the long run.

Shop for the best rates: If you take out a private student loan, shop for the best rates and terms. Compare offers from multiple lenders and choose the one that offers the most favorable terms and repayment options.

Understand the repayment terms: Before you take out a student loan, understand the repayment terms. Federal student loans offer various repayment options, including income-driven repayment plans that can help make your payments more manageable. Private student loans may have stricter repayment terms, so read the fine print before you borrow.

Consider loan forgiveness programs: If you plan to pursue a career in public service, education, or other qualifying fields, you may be eligible for loan forgiveness programs to help you repay your student loans. Research these programs and see if you qualify.

529 Plans

529 plans are tax-advantaged investment accounts designed specifically for education savings. Contributions grow tax-free, and withdrawals for qualified education expenses are also tax-free at the federal level.

Many plans offer age-based investment options that automatically adjust asset allocation as your child nears college age.

Contributions to these accounts grow tax-deferred, and withdrawals are tax-free when used for qualified educational expenses.

Each state has a maximum 529 plan contribution per beneficiary, and the aggregate contribution limit ranges from $235,000 to over $550,000.

While there are exceptions (like 5-year gift tax averaging), contributions to 529 plans are treated as gifts for federal tax purposes. If you contribute more than the tax exclusion amount, you must report the excess on IRS Form 709.

Series I Bonds

Series I savings bonds can be an excellent option for parents who want to save for their child's education in a safe and low-risk way. The US Treasury issues these bonds and offers a fixed interest rate, adjusted twice yearly based on inflation. The interest rate on Series I bonds is typically higher than what you would get from a regular savings account, which can make it a better investment option for those looking to save for college.

One of the most significant benefits of Series I bonds is that they are a safe investment. They are backed by the US government, meaning they are virtually risk-free. Unlike stocks or other investments, the value of Series I bonds will not decrease due to market fluctuations.

Another advantage of Series I bonds is that they are tax-deferred. You only have to pay taxes on the interest earned once you redeem the bond. If you use the money to pay for qualified education expenses, like tuition or books, you can avoid paying taxes on the interest altogether.

Series I bonds can be purchased directly from the US Treasury through their website or through a financial institution. You can purchase them in any amount above $25.00 up to $10,000 per person per calendar year.

These bonds have a maturity period of 30 years, but they can be redeemed after one year. Therefore, you can use the money to pay for college expenses once the bond is at least one year old. However, if redeemed before five years, these bonds are subject to an interest penalty equal to three months of interest earned prior to redeeming. After five years, there would be no interest penalty.

Coverdell Education Savings Accounts (ESAs)

Coverdell Education Savings Accounts (ESAs) are a type of tax-advantaged investment account designed to help families save for education expenses. Contributions to Coverdell ESAs are not tax-deductible, but earnings grow tax-free, and withdrawals for qualified education expenses (such as tuition, books, and room and board) are also tax-free.

One of the advantages of Coverdell ESAs is that they offer more flexibility in terms of investment options compared to 529 plans. You can invest in stocks, bonds, and mutual funds, and these accounts can even be self-directed.

Coverdell ESAs can be used for K-12 expenses and college costs, making them a good choice for families who want to save for private school tuition.

There are some downsides to Coverdell ESAs.

The annual contribution limit is relatively low, currently set at $2,000 per beneficiary per year.
These accounts have income limitations with the ability to contribute phasing out for those earning more than $110,000 per year (or $220,000 for married couples filing jointly).

Roth IRAs

A Roth IRA is an individual retirement account that allows you to save for retirement while providing tax-free growth and tax-free withdrawals in retirement. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning you don't get a tax deduction for contributions. However, the earnings grow tax-free, and qualified withdrawals are also tax-free.

Your eligibility to contribute to a Roth IRA is based on your income level.  For 2024, your Modified Adjusted Gross Income (MAGI) must be under $161,000 and, if you are married and filing jointly, under $240,000.

In 2024, the contribution limits to a Roth IRA were $7,000 for those under age 50 and $8,000 for those age 50 or older.

Roth IRAs can be used to fund a child's education. Contributions can be withdrawn tax and penalty-free at any time, subject to some qualifications.

Custodial Accounts

Trust accounts, structured as UTMAs (Uniform Transfers to Minors Act) or UGMAs (Uniform Gift to Minors Act), can be an excellent option for parents who want to fund their child's education. These accounts allow parents or other custodians to manage assets for a minor until they reach the age of majority, typically 18 or 21, depending on the state.

One of the most significant advantages of UTMAs and UGMAs is their tax benefits. For 2024, the first $1,300 of unearned income by a child under 19 is exempt from federal income tax. The next $1,300 is taxed at the child's lower tax rate, typically much lower than the parent’s. Anything above $2,600 is taxed at the parent’s marginal tax rate.

Another advantage is flexibility. The funds can be used for any purpose that benefits the child, including education expenses.

UTMAs and UGMAs can be opened at most financial institutions, and the funds can be invested in various assets, including stocks, bonds, and mutual funds, allowing parents to choose investments appropriate for their child's age and risk tolerance.

Once the child reaches the age of majority, they have complete control over the funds in the account. Sometimes, this is a less desirable feature for parents who may be concerned about their child taking control over these assets at such a young age, especially if the value of the account is significant.

UTMAs and UGMAs can impact a child's financial aid eligibility, so consider this issue when deciding whether to use this type of account to fund education expenses.

Final Thoughts

Investing in your child's education is a profound step towards securing their future. As tuition and associated costs continue to escalate, the value of early and strategic planning cannot be overstressed.

By understanding the variety of funding options, you can leverage these tools to mitigate the financial burden of higher education. Each option offers unique benefits and can be tailored to fit your financial situation and your child's educational needs.

With diligent planning and informed choices, you can give your child the educational opportunities they deserve without compromising your financial health.

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