Can I prepare my children for college debt burdens?
For some families, the answer is yes.
In 1970, 11% of adult Americans had earned a college degree. These few were considered the “best and brightest”. At the time, a college degree was seen as a sure fire way to enter the middle class. Today, a higher number—over 30% — have degrees, and yet the returns are lower.
Yet many degree-holders wind up in jobs that don’t require the credential. For example, in 1970, less than 1% of taxi drivers had college degrees. Four decades later, in 2014, 15% did. Despite rising costs, a college degree is no longer a guarantee of a good job.
Since 2000, the cost of college has more than doubled while consumer prices grew by just 45%, image from Dow Jones
Recent graduates face high debt burdens
This has caused the debt burden for recent graduates to soar For example, in 1970, the average debt for a political science graduate was $13,169 or 39% of the average first-year salary of $33,912 in 2015 dollars. By 2015, per-student debt had increased to $24,900 which is a significantly higher portion (66%) of the student’s first-year salary of $38,000, according to National Association of Colleges and Employers.
“By 2015, per-student debt had increased to $24,900 which is a significantly higher portion (66%) of the student’s first-year salary of $38,000 than it was in the 1990s”
– Dana Grigg
In contrast to the declining benefits of a degree between 1970 and 2010, the costs keep rising, especially for high-income families. Tuition for all public and private universities increased at a real annual rate of 4.95%, according to calculations from University of Michigan economics and finance professor Mark Perry.
The burden has fallen mostly on upper-middle-class families. In California, public school tuition more than doubled between 2004 and 2014. Tuition hikes typically accompany increases in means-tested student aid. As a consequence, high-income and high-net-worth families bear the brunt of these increases in tuition.
Many families have resorted to the use of debt to fund the gap between soaring tuition costs and stagnant incomes. For example, in 1970, the average debt for a political science graduate was $13,169 or 39% of the average first-year salary of $33,912 in 2015 dollars. By 2015, per-student debt had increased to $24,900 which is a significantly higher portion (66%) of the student’s first-year salary of $38,000, according to National Association of Colleges and Employers.
529 plans: an alternative to debt
One good way to do it is to set up a 529 plan. 529 plans are tax-advantaged, long-term investment vehicles designed specifically for students’ future higher education expenses. Money invested in the plan grows federal and state income-tax free. The distributions are also tax-free for qualified education expenses and can be easily rolled over for another child if not all the funds are spent. Also, most plans have zero or very low minimum monthly contribution limits, making them attractive to families regardless of income level.
What expenses do 529 college savings plans cover?
So long as the money in these plans are used to pay for qualified distributions, the money in the plan is not subject to taxes of any kind. Under current law this includes:
- Undergraduate & graduate school tuition & fees
- Books, room & board
- Transportation
- Some extracurricular expenses
- Up to $10,000 per year private K-12 tuition
Given that a student who goes on to grad school can expect to pay hundreds of thousands of dollars in these expenses, these plans are very difficult to over-fund and award the account holder with numerous tax benefits.
Transferability & contributions
Under current law, there are no limits on the transferability of 529 plans or on who can be a beneficiary. If a plan is over-funded, the owner has until the student reaches the age of thirty to transfer the account to a new beneficiary
Contributions can be made by anyone to the plan, not just the account owner.
Possible tax credits
529 plans are administered by states and state-government-linked organizations. Numerous states actually offer tax advantages for individuals to set up 529 plans.