How to Pay for College

As of mid-May, the stock market is down close to 40 percent from its peak in October 2007. And a college tuition bill will be arriving in your mailbox in a few weeks for the fall semester of the 2009 school year. What are you going to do?

Like any large expenditure, these decisions can cause financial stress. But in such uncertain times, what method of funding college makes the most long-term sense? The key is that you do have some alternatives, such as the following:

529 plans

If you have a 529 plan, chances are you have been saving into it for years and investing the money into a mixture of stock and bond funds. Depending on how much of the account is in stock funds, you may be back to the level you were years ago, since the market has been down so much. While that is certainly frustrating, it does not mean you should throw in the towel now and liquidate the whole account or act on current emotions.

You may first want to look at the specific holdings in the account. If you own bond funds, chances are they have held up well in this market. It may be appropriate to sell off these bond funds to pay for college in the near term, while holding the stock funds a little longer to see if they can recover. This allows you to continue to fund college using the tax-free 529 plan while not selling a fund that is potentially down. Of course, there is no guarantee that the stock market will come back by the time the funds are needed, but this strategy may buy you some time.

For parents who are still saving for college for young children, the 529 absolutely still makes sense as a college savings vehicle. Take advantage of the tax-free treatment and the down market to make regular disciplined contributions to your child’s plan. With a longer time horizon, you may be happy that you did when that first tuition bill arrives years in the future.

Education IRA

While not quite as popular as the 529 plan, education IRAs are still used by many parents to save for college. The funding maximums are much lower than a 529 plan, and they are not marketed as much, but they remain a good savings vehicle for college. Follow a similar strategy as with 529 plans of selling funds that have weathered the storm, and that may ease the pain of writing those tuition checks.

Home equity line of credit

One of the silver linings in this economy are very low interest rates for everything from mortgages to home equity lines of credit. If you have a credit line in place, it may make sense to use it to pay for college. This way you avoid having to sell an investment that is temporarily down. Plus, you can deduct the interest expense (subject to some guidelines; consult your accountant).

Cash flow

Another way to avoid selling an investment that is down to pay for college is to use your free cash flow by setting up a monthly payment system (as opposed to paying for the semester in one lump sum). Obviously, this option is not realistic for everyone, but it could buy you some time for your investments to recover before liquidating.

It is important to consult your advisor or tax accountant when discussing these or any investment ideas. Remember, the 529 and education IRA must be used for college-related expenses. If they are not, you may be subject to taxes and a penalty. So you don’t want to make a short-term decision that can have long-term consequences for your finances, such as having extra money left in one of these accounts at the end of the child’s college career. However, looking at these strategies in conjunction with your overall financial plan may make sense.

James R. Miller, CFP, is senior vice president of Tilson Financial Group, an independent financial planning firm in Chapel Hill. You can contact him with questions at jmiller@tilsonfinancial.com.

Categories: College Planning, Finance, Money