According to the College Board, the average cost of tuition for the 2014-15 school year was $31,231 for private schools, $9,139 for in-state residents at public schools, and $22,958 for out-of-state residents at public schools.
These numbers are shockingly high. What's more is that these numbers do not take into consideration housing, meals, books, school supplies, or other expenses associated with college.
The cost of college has many parents and students alike questioning (or maybe freaking out about) how to afford these outrageous bills. The Wall Street Journal recently answered questions regarding non-conventional ways to pay for college. I will attempt to summarize the article here, adding my own insight where applicable. For those of you with a Wall Street Journal online subscription, you can see the full story here.
Receiving help from a grandparent
Grandparents often set up college trust funds or saving accounts for their beloved grandchildren. This undoubtedly helps mom and dad, but what are the consequences for Grandma and Grandpa? Having a grandparent pay tuition directly to a non-profit school results in no gift tax. However, unlike a donation directly to the school, tuition payments are not deductible for the grandparent. The reason stems from the "benefit" test. Here, the student-- not the grandparent-- benefits by way of his reduced education costs.
A grandparent's direct payment to the college also counts as cash support. Therefore, this option may affect the student's individual financial aid eligibility.
A grandparent's direct payment of funds to a grandchild, whether for educational use or otherwise, will be deemed a gift and may have adverse gift tax consequences if above the $14,000 annual gift tax exclusion amount. A gift to a grandchild will also face a separate generation skipping tax if above the $14,000 generation skipping tax exclusion amount. Lastly, as always, it is the gift giver and not the gift receiver that pays any gift tax incurred.
Paying for college with an IRA
This option, though viable, does not come without warning. First, taking money out of an IRA can result in income tax on the distribution, unless the contributions to the plan were made after-tax. Second, this option could also negatively affect financial aid eligibility. Third, and perhaps most importantly, removing money from your IRA could largely impact your retirement. A 30 year old with $40,000 in an IRA account, assuming no further contributions are made and a 6% rate of return, stands to grow that account to $411,000 by the time he is 70. If he were instead to take out the money for grad school, he would do so at the cost of all the future years of growth.
Borrowing from a retirement account can be risky in general. Remember: it is easier to get an education loan than it is to get a personal "retirement" loan. If you intend to borrow from your retirement plan, or reduce your contribution amount, you must first do a thorough and realistic calculation of how much money you will need for your retirement years. This is true whether you are considering college for yourself or your child(ren).
How about a 529 College Savings Plan?
A 529 plan, also known as a qualified tuition plan, is "designed to encourage saving for future college costs." They are authorized under the Internal Revenue Code, but sponsored by states, state agencies, or educational institutions.
If you currently have a plan, but it's simply not enough, check the rules on who can contribute. Some plans allow grandparents or other third parties to contribute. If you have a plan that allows non-owner contributions, be sure to check to see if the non-owner can receive a state tax deduction or credit. Unfortunately, California is not one of those states that offers a state tax deduction for contributions, and Nevada does not have personal income tax (and therefore a deduction/credit is inapplicable). If you live in a state that does allow for deductions or credits, the chances are that those deductions will be allotted to the owner of the plan
Generally, contributions by non-owners count as gifts. It is therefore always necessary to be mindful of the $14,000 annual gift tax exclusion amount. There are some options for getting around this $14,000 ($28,000 per couple) limitation though.
Congress also gave us the 5-year election, which allows you to contribute as much as $70,000 ($140,000 per couple) into a child's 529 account without exceeding the gift-tax annual exclusion. Under the election, this year's contributions are split into five equal chunks, with the pieces reported as gifts and applied against the gift-tax annual exclusion over five consecutive years.
There is another option for making large upfront contributions to a 529 account without using up any lifetime exemption. The donor must name himself as original beneficiary of the 529 account, and then make an annual rollover of the annual-exclusion amount to another 529 account that has the child named as beneficiary. Each rollover will be a gift eligible for the gift-tax annual exclusion.
Overall tips: The Wall Street Journal suggests that parents or individual seeking to save money on college expenses do the following:
- Try community college for a year or two; typically speaking, employers are more concerned with the college from which a student graduates, and not where she starts out.
- Consider loans in moderation. Will the degree sought provide you or your child with the means to pay back in a reasonable manner? Will it increase your earning capacity significantly over the term of your life? Be mindful of interest rates: they can escalate your loan quickly in the case that payments cannot be immediately made!
- Always consider the option of part time school to cut costs, or part time work to help pay costs, or both!