The Worst Ways to Pay for College

The Worst Ways to Pay for College

Paying for a college education is daunting. Unless you’re able to catch a free ride at a military academy and pledge your life for six or so years of duty to country, then funding education becomes an onerous task for parents and students alike.

The best ways to pay for college come in the form of scholarships, grants, tuition reimbursement, and ways that others pay for your education in return for further service or reward for past deeds.

The common ways for paying for college usually mean parental/grandparental/relative savings or outright gifts. Coverdell accounts and 529 plans make up the majority of these savings vehicles. Savings can also come from Uniform Gift to Minors Act or Uniform Trust for Minors Act accounts. These accounts pay taxes as they grow while the Coverdell and 529 plan investments grow without paying taxes as long as they are used for “qualifying” education expenses.

Then comes the dreaded loans obtained by students and parents. Student loan debt has now passed the level of credit card debt in America. They go by names like Stafford, Perkins, and PLUS. Some are federal, some are private. Some are student obtained and some are at the behest of parents. They also can’t be discharged in bankruptcy. There are some tax credits available for certain loans at certain income levels. There’s not a lot of free lunch here, but rates have remained fairly low by historical standards as the need has mounted.

Then fairly frequently we see parents take out a Home Equity Line of Credit (or even a second mortgage) to pay for their children’s college. There could be some tax savings here, but there are limits too. These HELC loans are variable rate and payments can increase over time. Second mortgage payments are usually fixed. In addition, becoming mortgage free for parents is a delayed financial goal. A result could be dramatic downsizing in retirement to pay off these loans.

But what are the worst ways to pay for college?

· Credit cards. So easy to use and so difficult to maintain payments above a minimum balance. No grace period like student obtained loans. Interest rates are always in the double digits except for some teaser rates that usually last no longer than a year. Most colleges gladly accept credit card payments, so watch out for this easy transaction.

· Cash in your (non-Roth IRA) retirement account. Not only do you as a parent or even as a student fall behind in saving for retirement (or financial freedom), but the tax consequences are terrible. More income taxes due and a 10% penalty unless you are age 59 ½ or older. You can cash in your Roth IRA or Roth 401k and not pay tax on your original contribution, but you will pay tax and penalty on the gain.

· Co-signing for a loan you can’t afford to pay, if the student defaults. Parents and other relatives have been caught in this bind. It damages family relationships and usually risks someone’s retirement plan, in my experience as a financial advisor.

There are probably even more terrible ways to pay for college, but please start at the top of my article for the best ways and work your way down. Avoiding the last three will avoid even bigger problems with family and close friends who might be involved in funding college.

Jim Ludwick
Jim Ludwick

Jim Ludwick is the founder of MainStreet Financial Planning. His varied education and life experiences have enabled him to apply his knowledge and experience into useful solutions for personal financial problems. His writing and broadcasting activities allow him to help many more than just individual clients. He loves a microphone.

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