As a new generation prepares for college, it pays to think creatively about financing one of life’s major expenses.
Members of Generation Z have good reason for optimism. Born between 1995 and 2010 and 69 million strong, they’re the first with no memory of life without the Internet. Eager, bright and digitally savvy, they’re already being hailed as budding entrepreneurs who can’t wait to change the world—even though the oldest are barely in their twenties.
“Wherever we’re going with the digital revolution, the young are going to take us there first,” says Paul Taylor, author of The Next America and former Executive Vice President of the Pew Research Center. “They give us hopeful signs that we’re an economy that still prizes innovation and moves fast.”
Gen Zers are using that spirit of innovation to reshape what they expect from college. More than 60% say they want to study entrepreneurship, and nearly three-quarters think students should be allowed to design their own curriculums, according to a 2014 study by Northeastern University.
“Members of Gen Z are passion-driven when it comes to their college experience,” says Keyaun Heydarian, a budding entrepreneur who, as a high school senior, co-founded a college tour company called CollegeRoleModel.com. At the same time, says Heydarian, now a freshman at George Washington University in Washington, D.C., formative experiences such as the recent recession have left Gen Z with deep concerns over their financial future, including paying the ever-rising cost of college.
Strategies for families
In fact, while 80% of students see college as a necessity, 60% feel stressed about the cost, according to Ohio State’s National Student Financial Wellness Study. “Still, even those who are worrying think college is going to pay off for them in the future,” says Anne McDaniel, an Ohio State researcher and co-author of the study.
To meet those costs, families are increasingly looking for ways to save rather than borrow, says Jeffrey H. Winick, Senior Vice President and Senior Wealth Strategist with Regions Private Wealth Management. “We see many parents who experienced large college debt when they were starting out themselves. They don’t want their children to experience the same.” The best ways to save may involve a variety of options, including (but not limited to) the all-but-ubiquitous 529 plan.
The 529 Plan
These plans have become the go-to choice for millions of families, thanks to their tax advantages and flexibility. You can generally invest up to $14,000 per year ($28,000 for a couple) in a 529 plan, where the money can grow tax-free. And as long as you spend it on tuition or other qualified educational expenses of the designated beneficiary, the money is not subject to federal tax and generally is not subject to state tax.
As another advantage, 529s allow you to “front-load” up to five years’ worth of contributions at the outset, subject to annual exclusion gift requirements. While front-loading can give your savings a head of steam or make up for a late start, it’s important to consider market conditions and your liquidity needs before committing a large sum, Winick advises.
As for flexibility, 529s enable parents or grandparents to control the money until it’s used, and switch beneficiaries as needs arise. “If one child gets a full scholarship, you can shift the benefits to another child who may be facing tuition at an expensive private school,” Winick says.
Other ways to save
Looking for ways to ramp up savings beyond the 529? Consider these:
- Roth IRAs, while generally used as retirement accounts, can also be effective college savings vehicles, particularly for grandparents or parents who had children later in life, says Winick. With a Roth, your contributions are after-tax money, but once in the plan your savings grow tax-free, and you pay no income tax if the money is later distributed as part of a qualified distribution. While 529s impose a penalty if the money isn’t used for education, proceeds from a Roth can be used for any purpose. Among the caveats, you must be at least 59½ to remove funds from a Roth tax-free. Although Roth IRAs restrict contributions to those earning less than $116,000 ($183,000 for couples), affluent individuals may be able to make a non-deductible contribution to a traditional IRA, and afterward convert to a Roth, Winick says. However, to the extent that there are earnings prior to conversion, those earnings are taxable, and if there are other traditional (deductible) IRA accounts, the resulting immediate tax impact may outweigh any advantages gained through the conversion strategy.
- Prepaid tuition programs are offered by several states. Similar to 529s, these plans typically enable you to prepay state college tuition at today’s rates. You can buy prepaid plans for your child at any age—and with college costs rising each year, the earlier you buy, the greater the potential savings.
- Baccalaureate bonds are offered by several states as well. They are usually set up to mature when your child enters college—with a discount on tuition when you use them.
Education for life
Since different approaches will work best for different situations, it’s best to carefully consider the options and then meet with an advisor, Winick says. Paying for college may be a good opportunity to instill lessons in Gen Z about financial responsibility and money management. Without swamping your kids in large debts coming out of college, you might ask them to pay for a portion of their college expenses in order to feel vested in their own education. Says Ohio State’s McDaniel, “If they have absolutely no stress about finances, it could mean they’re not thinking about them at all.”
And there are other ways for your child to have a vested interest in college costs, Winick says. For example, you might make paying for college contingent on your child maintaining a certain grade point average through high school and during college.
And, when it comes to preparing your Generation Z child for life, there’s no time like the present. Says Winick: “The earlier you start saving, the more flexibility you have to see what works best, and how that fits into your long-term financial plan.”
