School Savings Programs
Some of the most popular ways to save for school are the Coverdell Education Savings Account, the 529 Savings Plans, College Sure CDs and University Sponsored Pre-Paid Tuition Savings Plans.
- (1) Coverdell Education Savings Accounts (ESAs)
- (2) 529 Plans
- (3) College Sure CDs
- (4) Prepaid Tuition Programs
There are three or four different savings programs designed especially for college education planning. The first one is of special interest especially to higher income families. You can contribute up to $2,000 to an ESA (now known as Coverdell) and the growth in that savings account over time is tax free. The actual $2,000 you put into the account each year you do not get to deduct on your taxes, but when you start withdrawing the money, as long as you use if for college expenses, you do not pay any tax on any of it including the amount the account grew from interest, dividends, capital gains. Its all tax free. You are only allowed to contribute up to $2,000 each year to the account but you can do a 529 plan also if you want to do more than $2,000.
The 529 State Savings Plan
Since the 529 plans are run by the individual states, there can be some variation in the details of how the program works in your state. You are strongly urged to seek the details from your state program. You can contribute up to $12,000 per year and not only does it grow tax deferred but in many states the initial contribution is either all or partially tax deductible. It is important to understand that “tax-deferred” does not mean tax free. Section 529 provides that the money grows tax deferred. Then there was a temporary ten year period from 2001 thru 2010 that congress later made the money tax free for that ten year time frame.
The College Sure CD
Annual cost of a higher education:
The costs of higher education are compiled and averaged annually into The Independent College 500 Index. The schools used in the average are the 500 highest priced schools.
One-year increases in average published tuition, fees and room and board at public four-year colleges and universities adjusted for inflation were just under 1.0% in 2008‑09, 9.3% in 2009‑10, 4.5% in 2011‑12. and 4.25% for the upcoming school year 2012‑13.
A look at the last two academic years shows the changes in total costs (tuition, fees, room, and board):
- for 2011-2012: $42,168
- for 2012-2013: $43,960
This is an increase of 4.25 percent for this year. Keep in mind the totals shown are for a full academic year, not per semester. These figures include room and board. For a four year degree, if there is zero inflation for the next four years….$44,000 x 4 years = $176,000.
Scary numbers for anyone expecting to shoulder the cost of a college degree over the next four years. The portion of this cost that represents tuition and fees was $33,216. The portion of this cost that represents room and board was $10,744.
Interest Paid on College Sure CDs
College Sure certificates of deposit (DCs) are the only savings plan that are pegged to increased college costs. Other savings plans are usually tied to the prime rate. College Sure CDs allow a rate of return based on the inflation of college costs. Each July the rates are reset at 1.5 percent less than the annual rate of inflation in the college cost index. The inflation rate is decided by college inflation, as measured by the College Board’s Independent College 500 (IC 500) Index.
As can be seen above, the last few years, college inflation rates have moderated a bit from the double digit rates often seen over the last 20 years. Over the past twenty-five years, the annual college inflation rate has ranged from a high of 14.35% to a low of 1.00%.
Inflation Adjusted Tuition and Fees
Right now, college inflation rates are much higher than overall inflation in the overall economy. Inflation in the overall economy has been between 0.5% and 2.2% since mid-2008. In the graph above, “inflation adjusted” means these are the percent increases in excess of inflation, they have reduced total percent increase by the amount of inflation in each of the years and thereby show how much extra college costs have gone up greater than the inflation rate.
Inflation – Overall Economy
Inflation chart courtesy of the calculatedriskblog
There are some advantages and some disadvantages to College Sure CDs:
Advantages of College Sure CDs
- if tuition inflation picks up again, you are in a sense insured against big increases;
- the minimum deposit is only a thousand dollars for your first CD;
- your money is insured by the FDIC up to $250k (used to be only $100,000 and may return to $100,000 in the future);
- no enrollment fees or other management charges (which is why you rarely see this investment marketed or advertised to a parent saving up for a child’s education. The financial institution and salesmen don’t stand to make a profit so they have little incentive to spend time trying to sell the vehicle);
Disadvantages of College Sure CDs
- interest earned is taxable except for Montana and Arizona through 529 plans. Also, interest is not taxable if you are a resident of Maine, Kansas, Pennsylvania, or Missouri. Please check with your local lender and/or tax professional to ensure your interest is handled properly for tax purposes;
- the college sure CD will show a smaller profit if college costs rise more slowly in the future;
- as with any CD, long term growth potential is limited compared to investment vehicles such as stocks and mutual funds;
For practical purposes, you can think of the College Sure CD as being very similar to the college prepayment plans offered by most states.
University Sponsored Prepaid Tuition Savings Plan
You can save for college by paying into a savings account at your chosen college. You can do this with both in-state and out of state schools. The earnings on these accounts grow tax deferred until they are withdrawn and then will be taxed at the student’s lower tax rate instead of the original contributor’s tax rate.
Some details of these plans do vary from state to state so please check for the state you are in or are considering. Typical rules are:
The parent maintains control of the account if they are the contributor to it.
Income level is not a factor. You can do this regardless of your household income and you can contribute $100,000 per year if you want to. The intended beneficiary can be changed if the first beneficiary does not end up attending university.