It’s no secret that a college education can cost a pretty penny, and the bank of mom and dad remains the primary means of support: According to a 2021 Sallie Mae report, parents’ income and savings cover 45 percent of college costs for a typical family, by far the largest source of funding.
If paying for some or all of your children’s education is one of your financial goals, then saving early and often is the best strategy. That said, sometimes life gets in the way, and saving for college can get delayed or be subject to starts and stops. If you’re concerned about paying for college because you haven’t saved as much as you would have liked by now, below are a few options to consider.
4 ways to help pay for college costs
1. Consider opening a 529 plan
If you haven’t thought about opening a 529 plan, it’s never too late. Even if you only have a few years left until your child heads off to campus, the tax efficiencies you can get through a 529 plan can still make it worthwhile to consider.
A 529 plan is a state-sponsored education savings program that allows you to invest money for college that grows tax-deferred. You won’t pay federal taxes on the withdrawals if you’re using it to pay for qualified education costs, and some states offer state tax deductions or credits on your contributions. If you don’t end up using the funds for one child, you can change the beneficiary to another child (or really anyone looking to pay for higher education).
There are no annual contribution limits for 529s, although contributions to a 529 are considered gifts for federal tax purposes. This means you or anyone who wants to contribute to your child’s college fund can gift up to $16,000 in 2022 and still fall within the annual gift-tax exclusion amount.
Even better news? “With a 529 plan, you can frontload those contributions,” says Jennifer Raess, CFP®, Advice Integration Lead at Northwestern Mutual. That means anyone who wants to help save for your child’s college can contribute up to five years’ worth of the annual exclusion amount — so up to $80,000 in 2022 — without having to consider it a taxable gift.
Discuss this strategy with your tax advisor first to make sure it makes sense for your situation and so you know which forms you would need to file with the IRS.
“That could be a good way to get some funds in there rather quickly, if you have that available,” Raess adds. The catch is that the person making the contributions wouldn’t be able to gift any more money to your child for the next five years without it counting toward their lifetime gift tax exclusion.
2. Consider a prepaid tuition plan
A prepaid tuition plan is technically a prepaid 529 plan, but it’s structured a little differently than a regular 529 savings plan. With a prepaid plan, you’re essentially making payments today toward future college costs, but at current tuition rates.
The big pro is this means a smaller portion of the overall savings will get eaten up by inflation. If a prepaid tuition plan is available in your state, it could be a good way to get a jump on some college expenses now at a lower cost. Most have high contribution limits and will allow your earnings to grow tax-free over time, and friends and relatives can help contribute. “There are different requirements around them, including some residency requirements, but if you can find one accepting new applicants and you meet its requirements, it does allow you to lock in tuition rates today,” Raess says.
A few downsides are that fewer states offer prepaid tuition plans and they usually only cover tuition and fees; traditional 529 savings plans tend to cover a wider scope of qualified education expenses.
3. Tap your home equity
Many parents end up taking out public or private educational loans to pay for their kids’ college; the Sallie Mae research shows that 11 percent of parents took out federal Parent PLUS loans to help cover college costs for the 2020 to 2021 school year.
If you have significant equity in your home, an alternative could be to use that home equity to your advantage. “A home equity loan or HELOC will generally have a lower interest rate because of your home guaranteeing that loan,” Raess says.
A home equity loan or line of credit allows you to borrow against the equity in your home and can help you access funds relatively quickly. However, as with other forms of debt, weigh the pros and cons before you go this route. Can your budget easily absorb a new debt payment? And will it impact your long-term financial goals? It’s also important to remember that if you default on that debt, your home is at risk.
4. Tap the cash value of a life insurance policy
But if you have whole life insurance that has accumulated cash value, you can access the cash value for any reason, including to pay for educational costs. “You could take out a loan against the policy, which could come out tax-free depending on your basis and the type of policy you have,” Raess says.
Funds can typically become available quickly and repayment options are usually very flexible. Just keep in mind that if you pass away before paying back the balance of your loan, your death benefit will be reduced by the amount of your loan. Similarly, if you borrow too much and the balance grows too high, your insurer may surrender your policy to pay it off.
Why you should try to avoid retirement savings to pay for college
According to the Education Data Initiative, 21 percent of parents say they would use their retirement savings to pay for college, if necessary. While it may be tempting to dip into your nest egg to help your kids out, you shouldn’t do so at the risk of putting your retirement in jeopardy.
“You really need to make sure that you are on track for retirement,” Raess says. “In this circumstance, it really is OK to put yourself first.”
For starters, remember that you never know what kind of financial aid package your child will ultimately qualify for. When the time comes, you and your freshman-to-be will fill out the FAFSA and/or a CSS profile, and you may find they are eligible for scholarships, grants, student loans and direct aid from the college that can help cover most or all their costs. Tapping that aid first should take priority, because while college students can take out student loans to fund their education, it is much harder for retirees to finance their living expenses.
What’s more, depending on what type of retirement account you have, early retirement withdrawals (before age 59½) for college costs may trigger taxes and an additional 10 percent penalty, plus you’ll be missing out on the potential for future investment returns. (Distributions for qualified college costs from a Traditional or Roth IRA won’t be charged the 10 percent penalty, but those from a 401(k) will.)
“You could be living for many, many years in retirement,” Raess says. “Things are also costing more in retirement, and health care costs keep going up. In this circumstance, work with an advisor to make sure you’re on track for retirement first, and then see what you have left over that you might allocate for your child’s education.”
This article is for informational and educational purposes only and should not be interpreted as financial advice or investment recommendation. This publication is not intended as legal or tax advice. Northwestern Mutual Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation. The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement funding for education will reduce the death benefit and may affect other aspects of the policy. All investments carry some level of risk including the potential loss of all money invested.