Funding the Cost of College

It’s no surprise that college tuition is undeniably expensive by most measurements and it’s not getting any cheaper. Communicating the reality of the cost of college requires a candid conversation with your children. 

Start planting the seeds to have that candid college discussion with your children as early as possible. 

For example, you could open a 529 plan or even a simple bank account specifically earmarked for your child’s tuition cost. Make an agreement with your child that half of every check they receive for birthdays or holidays would go toward funding their college costs, instilling an understanding to your child that college is an investment which requires long term savings. 

This also allows you to have an open and honest conversation with your child about the cost of college by the time they are a teenager since the idea has been present throughout their childhood. 

There’s no perfect age to bring up the college talk, but most experts agree that sitting down with your teen during their junior year of high school to work through the numbers is the latest you would want to have the conversation.

Ideally, you have an honest discussion with your teen about including cost, living expenses, academic requirements, extracurricular activities BEFORE the enrollment applications are submitted. 

Too often, students apply to the school of their dreams and get in only to be brought back to reality when cost comes into the picture. 

Alternative Ways to Fund the Cost of College

Talking to your kids about the cost of college can be daunting enough, let alone figuring out how to fund their college education.

The fact is, there are other ways to consider covering the rising cost of college tuition beyond the 529 plan. A 529 savings plan is essentially a tax-advantaged investment account you can contribute to, invest in, and withdraw from for college tuition and other qualified education expenses. 

One of the huge benefits of a 529 plan is there is no contribution limit set by the IRS, and the fact that distributions are completely tax-free as long as they are used for qualified education expenses. 

The downside of a 529 plan is the general lack of flexibility in tax-advantaged distribution options if for instance the beneficiary listed on the account decides not to attend college.

That begs the question then: what are some of the other ways to cover the gap in college funding beyond a 529 savings plan?   

Explore Work-Study Programs Offered At The School

Many schools offer federal work-study programs which offer students part-time jobs, typically either on or off campus, to help pay for the cost of tuition. 

Students can elect to be paid directly or request that the school apply the wages directly to education-related costs, such as tuition and room and board. If it is something you or your child are interested in, you should apply as soon as possible as funds are limited to these programs. 

Also, keep in mind your student cannot work as many hours as they want as the financial aid office will make a determination on hours depending on their schedule and academic progress.  

Consider Funding A Roth IRA

Parents may consider using a Roth IRA in addition to or instead of a 529 plan to save for college. 

Contributions to a Roth IRA are made with after-tax dollars and earnings grow tax-free, as with a 529. However, because a Roth IRA does not have to be used for the cost of college, it can be advantageous if there is some uncertainty whether a student will end up going to college or not. 

Roth IRA account owners are able to withdraw funds (contributions and earnings) penalty-free to pay for qualified educational expenses. However, withdrawals of Roth IRA earnings are still subject to income tax even though they would avoid the 10% early withdrawal penalty. 

For example, let’s say you have a Roth IRA that totals $50k, $40k of which is contributions and $10k of which is investment earnings. If you were to pull the full $50k balance, the $10k earnings portion would still be taxable income even though the $40k contribution would not. 

Because there are specific rules around qualified versus non-qualified Roth IRA distributions, it’s important to carefully evaluate the pros and cons of using a Roth IRA towards saving for college. Additionally, distributions from a Roth IRA count as income and can impact the student’s Free Application for Federal Student Aid (FAFSA) even if it’s a tax-free return of contribution if the money from a Roth IRA is taken during the students first two years of school. 

Explore Attending a 2-Year Program and Transferring

Parents can also talk to their children about attending community college for the first year or two before transferring to another school. There’s a lot of overlap in terms of coursework the first couple semesters of college, such as English, history, philosophy, and core science and math. As a result, students can save a lot of money on tuition by simply attending a local community college for a few semesters before transferring to a school of their choice. 

Attending community college for the first two years can save a student thousands of dollars, but there are downsides to this approach to consider, especially if you are hoping to graduate with a bachelor’s degree in four years. 

According to collegeboard.org’s “Trends In College Pricing 2020” average tuition for public two-year college is $3,770 compared to $10,560 for a public four-year in state institution or $37,650 for a private four-year institution. 

Based on these estimates, it’s possible to save tens of thousands of dollars annually by attending a 2-year community college and eventually transferring to a four-year school. 

Transferring those credits from a community college to another institution is a potential issue because there is no guarantee the institution will accept all or even some of your credits from community college. Therefore, you need to do your research, work with the admissions counselors of the schools you are considering, and determine how your credits would transfer to a given institution. 

Another major consideration is the admissions process for transfer students. The acceptance rate for four-year schools tends to be slightly lower for transfer students versus incoming freshmen, so it’s important to have your options lined up. 

That being said, based on the cost of tuition alone, taking at least some of your basic core classes at a community college can potentially save you thousands of dollars.   

Community college is a viable option, but there are downsides to consider like the transfer process, whether your credits will be accepted, and potentially extending the time it takes to obtain your four-year undergraduate degree. 

Summary

Be honest with your kids about what you can afford, but perhaps more importantly, what you are willing to pay for. Remember: you cannot take out a loan for retirement, so be candid with your kids and yourself about how the cost of college would be funded. 

Lay out all the options on the table including the possibility of attending a two-year program to cut costs and get some core classes out of the way before transferring to a four-year school. 

Before you take on any investment or retirement strategy, it is vital that you seek out proper investment and tax advice beforehand. Investment performance is never guaranteed and investments may lose some or all of their value. On top of that, there may be severe tax consequences if withdrawals are taken improperly and can have a significant impact on your portfolio and retirement. Although we provide Investment Advice and Personal Financial Planning Services, we at MWM do not provide tax advice and any tax advice should be rendered by a licensed tax professional such as a CPA.