How Will You Pay For College?

OCEAN CITY — Fifty years ago, California’s master plan for higher education called for every state resident to be able to attend college tuition-free. It was a bold goal, but in 1960 it only reflected what the country as a whole seemed to believe — that a college degree was essential for success and should become a national birthright.

But those were simpler times. California long ago began charging “student fees” (avoiding the word “tuition”). Nationwide, by the 2012–2013 academic year, the average annual total charges for tuition, room and board, and fees at a U.S. public institution had risen to an estimated $30,911 for out-of-state students and $17,860 for state residents, according to the College Board, a nonprofit education organization. The tab at private nonprofit colleges averaged $39,520.

That makes college a big-ticket item in almost any family’s budget. While most parents find ways of lowering the bill through financial aid, student loans and scholarships, carrying the full load could be a challenge.

So how are families getting a handle on the upcoming costs? These days, one way is to get an earlier start on building a college account. One popular choice is a 529 college savings plan. Sponsored by states, these plans have comparatively high limits on contributions, and they sometimes offer tax benefits. Account holdings have the potential to grow income tax–free, and as long as the money is used for qualified higher education expenses, there are no taxes to pay when funds are withdrawn.

During their 16 years of existence, 529 plans have become “easily the most popular higher education savings tool,” says Rich Polimeni, director of education savings programs at Bank of America Merrill Lynch. By the end of the third quarter of 2012, Americans had $163.7 billion invested in 529 plans, and that number is expected to grow to $237 billion by 2015, according to the Financial Research Corporation.

Yet for all their virtues, 529 plans also have some minor limitations. The investment options of the plan you choose — from among dozens of state-sponsored choices — may be relatively narrow, and you can change your investment allocation on existing assets only once a year, or upon a change in beneficiary. (You can, however, direct how new contributions get invested.)

Long before there were 529s, parents depended on another option that remains viable: custodial accounts that let you set aside money for children until they reach the age of majority (18, 19, 21 or 25, as defined by your state). These savings vehicles have a wide range of investment options. They also offer limited tax advantages.

A third alternative, the Coverdell Education Savings Account, offers tax advantages similar to those of 529s. But Coverdells are open only to those whose adjusted gross income is less than $110,000 for individuals or $220,000 for a married couple, and contributions are capped at $2,000 per year per beneficiary. While a Coverdell alone isn’t likely to cover the full cost of college, even if parents begin saving very early, it can give students a means of substantially addressing expenses.

Another alternative to a 529 would be to earmark money in a savings or investment account for a child’s college costs and then simply write a check when the tuition bills come due. Payments made directly to an educational institution for a child’s higher education aren’t subject to gift tax and don’t count toward your annual gift exclusion.

(The writer is a senior financial advisor and can be reached at 410-213-8520.)