Avoiding Student Loan Debt
For many college students the thrill of graduation can fade quickly as the price of their degree comes into focus. Nowadays, students who graduate from a four-year college are staring at repayments of student loan debt, on average, of about $23,000.1
For many college graduates, student loans become a sentence of years or even decades of monthly payments – potentially delaying or even jeopardizing their ability to buy a house, start a family and save for the future. Let's face it: A pile of debt is not exactly how you envision your son or daughter starting adult life.
And if your child goes on to law or medical school, that choice may mean six-figure student loan debt by the time he or she starts a career.2 Even choosing a public college or university instead of a pricey private school won't help so much. Over the past 10 years, tuition and fees at public institutions have increased annually at a far faster rate than private college tuition.3
A College Savings Strategy: 529 Plans
There may be an answer. Nailing down your college funding strategy now – or refining a current strategy – could boost your child's chances of getting a degree without taking on student loan debt. A key part of that strategy should be a 529 college savings plan.
Here's why. Contributions made to a 529 plan can potentially grow tax free, so your money has the chance to compound quickly than if it were invested in a regular taxable investment account. Withdrawals from a 529 plan are tax free when used for qualified higher education expenses, including tuition, room and board and other required fees4. With this tax advantage, even setting aside a small amount into a 529 every can month a big difference when it's time for your son or daughter to attend college. Monies can be used to pay for qualified higher education expenses at any eligible college, university, technical or graduate school in the U.S., as well as some foreign institutions.
Saving vs. Borrowing
Still not convinced? Consider the costs of borrowing for college versus the potential benefits of a tax-advantaged account (see chart, below). The average college student needs to borrow about $23,000 in student loans. Let's say that your child will wind up borrowing $30,000. By the time he or she pays off that loan 10 years after graduating, the total loan amount will be about $41,400 with interest—38% more than the principal. This is a hypothetical example for illustrative purposes only. Actual results will vary.
On the other hand, say you commit to a periodic savings plan in a tax-advantaged account. You set aside $200 every month when your son or daughter is born - that's $2,400 annually, or approximately $18,000 by the time he or she is seven and a half years old. Even if you stop saving at that point, you could potentially save $30,000 by the time your child starts college. That's money that your child would otherwise borrow and pay back over years.
Save It or Borrow It?
Take your pick: This chart compares the potential amount that can be saved in a tax-advantaged account over 10 years with a student loan's interest accumulation over 10 years.
Your child may still need some student loans to close the gap between what you save and what college actually costs. But starting a 529 account (or boosting contributions to a 529 you already have) can help narrow that gap - and help your son or daughter start post-collegiate life without the burden of student loan debt.
Use our calculators to help you project college costs, determine the advantage of a home state tax deduction and more:
1. Source of data: www.finaid.org
2. Source of data: American Bar Association, November 2009. Commission on the Impact of the Economic Crises on the Profession and Legal Needs: "The Value Proposition of Attending Law School." American Association of Medical Colleges. October 2010. "Medical Student Education: Costs, Debt and Loan Repayment Facts."
3. Source of data: Trends in College Pricing 2010, The College Board.
4. For withdrawals not used for qualified higher education expenses, earnings are subject to ordinary federal and any applicable state income taxes at the owner's marginal income tax rate plus an additional 10% federal tax penalty on earnings.GC0000.092.0411