Here at Lasso, we love featuring financial advisors who want to help investors connect the dots and reach their goals. This piece was co-authored along with Maggie Koosa of The Alchemists, Your Wealth Concierge.
According to one recent report, the average cost of a college education in the United States is a whopping $35,331 per year. When you take into account student loan interest rates and the loss of time in the workforce, the price skyrockets even further.
“When saving for college, most people think of 529 plans as the top/best option. As with most things in the financial realm, it depends. The top strategies I discuss with my people include 529 plans, Roth IRA’s, and cash value life insurance (CVLI).”
One of the reasons we like the Roth IRA is that when applying for FAFSA, retirement accounts and life insurance do not count as assets, whereas any accounts in the name of the student, including 529 plans, do. Assets and income are both factored into your FAFSA results.
Here are three savings tools to help you build up your savings for college.
1. Cash Value Life Insurance (CVLI)
What is CVLI?
Cash Value Life Insurance (CVLI) is a form of life insurance that comes with an investment aspect that you can withdraw or borrow against. A CVLI is considered a tax-advantaged account because the growth within the policy can be accessed tax-free, as long as the policy is maintained.
As with other investments, the policy needs to be in-place and funded over time in order to accumulate funds. Anything you put in a CVLI is post-tax, meaning it’s taxed upfront and you don’t have to pay taxes when you withdraw from it.
Do you have to use a CVLI to pay for college?
Unlike 529s, the money from CVLI can be used for anything you’d like. If the owner/insured passes away prior to utilizing the cash value to fund education, then the death benefit can cover such expenses.
What are the pros and cons of using CVLI for college?
There are no income or contribution limitations on CVLI, but there is one requirement: The insured must be insurable. For that reason, CVLI may not be available to everyone.
The investment options on CVLI can be limited, but are fairly inexpensive and akin to managed investment accounts.
2. 529 Plans
What is a 529?
A 529 plan is an investment account designed to be used specifically for education purposes, whether that be college, primary or secondary school tuition.
Like CVLI, 529 plans are tax-advantaged accounts, because they are funded with post-tax dollars and the money in them is allowed to grow tax-free. In other words, if you put in $10,000 and that grows to $15,000, you won’t have to pay taxes on the $5,000 growth as you would with normal investments.
Do you have to use a 529 for college?
While most people use 529s for higher education, the funds can also be used for primary or secondary school tuition as well as books, housing, computers, food and more – as long as those expenses are related to your education.
What are the pros and cons of a 529 plan?
529 plans vary from state to state in regards to contribution minimums and limits, as well as fees involved. Thankfully, you can choose any 529 plan offered in any state, not just the one offered in your state.
Again, contributions to a 529 plan are post-tax, and the money in them grows tax-free – but only if it’s used for education expenses. If you use money from a 529 for any other purpose, the earnings will be subject to income tax plus a 10% fee.
We can hear you asking, “But what if I save up all this money for college and then my kid gets a scholarship? What happens to the money then?”
Don’t worry. If a scholarship comes into play, you can withdraw up to the scholarship amount without any penalty. Same goes for if your child attends a U.S. military academy, becomes disabled or dies.
There are no income limitations, so 529 plans are available to everyone. As far as contribution limits, there technically aren’t any, but tax pros suggest staying within the annual gift tax exclusion, which is $15,000 in 2022.
There’s no way of knowing exactly how much you need to save for college, but if you save too much, the leftovers can be transferred to an eligible relative to use for education.
One downside to keep in mind: The investment options available for 529s are limited and can be expensive.
3. Roth IRAs
What is a Roth IRA?
A Roth IRA is the most common type of account out of the three options we’re reviewing here.
Roths are tax-advantaged accounts. Contributions are post-tax and can be withdrawn without tax or penalty at any time. The earnings from your contributions can be withdrawn penalty-free – but not tax-free – for a few different reasons, including higher education expenses for you, your spouse, children, or grandchildren.
Do you have to use a Roth IRA for college?
No. You can make a penalty-free withdrawal from a Roth IRA for several reasons, including medical expenses, permanent disability, to buy a home or if you’re called to active duty, among others.
What are the pros and cons of using a Roth IRA for college?
The biggest difference between a Roth and the other two account types is that there are income and contribution limits. If you’re eligible, you can contribute up to $6,000 per year, as of 2022.
On the plus side, there are a plethora of investments options available.
How Can You Decide Which Type of Account to Use for College?
When choosing how to save for college, ask yourself three questions:
1. How much can you realistically save per year?
If you think it will be less than or equal to $6,000, a Roth IRA may be the way to go. Of course, you may be using your Roth for retirement, so consult with your advisor before going this route.
If you plan on saving more than $6,000 per year, you may want to consider CVLI or a 529.
2. Is there a chance you will need the money for something else?
If the answer is yes, go with the Roth or CVLI. As we’ll see later, 529s are designated specifically for education purposes and you could be hit with big penalties if you try to spend them on something else.
3. Is your household income within the IRS income limitations for Roth IRAs?
If your income is too high, consider the Roth option for your employer-sponsored retirement plan (e.g., Roth 401(k), etc.) and also consider CVLI and 529 plans.
Maggie Koosa is the CEO of The Alchemists, Your Wealth Concierge. When she’s not supporting her community and clients with extensive financial planning expertise, you can find Maggie competing in sports, traveling, and spending time with her family.
You can find Maggie and connect with her in Lasso!