Guest post by Jamal L. Mahmood, a Certified Financial Planner® at Access Wealth Planning, LLC, in Roseland, NJ, who specializes in college savings planning and financial planning for families. He is also the editor of www.muslimpersonalfinance.com.
As a financial planner, one of the most frequent concerns I hear expressed from clients is how to prudently go about saving for their children’s future college education expenses. This is a challenge for any family, but for a Muslim family wishing to take certain faith-based concerns into account when meeting that challenge, it can be that much more daunting. Below are answers to some of the most common questions people ask.
How Much Will College Cost?*
– The 2013 national average annual cost of “in-state” public universities is $13,285
– The 2013 national average annual cost of private universities is $30,888
– The 2013 national average annual cost of Ivy League universities is $55,727
– The cost of tuition has historically risen by anywhere from 6-9% per year for the past fifty years
The historical inflation rates listed above essentially tell us that if history is a guide, the cost figures will double every 8-12 years. However, one bit of good news is that many experts feel that the rate of tuition inflation may slow down, since a continuation of the current trend would simply make paying for college impossible for too many families. But even if the rate of increase is less in the future, college costs will still represent a significant investment for most families.
How Much Should I Save?
There are several “cost calculators” available like this one here, that you can use to get an estimate for how much you need to save given your particular situation. You’ll find out how much you need to put away per month, per year, or as a lump sum, in order to have enough by the time your child is ready or school. If the required level of savings is too much to manage (and in my experience, this is the case for many, if not most, families), choose an amount that does fit your budget and add to it as time goes on. You might start with a small monthly amount, but increase it or make one-time lump sum additions as you get raises or bonuses, or windfalls from other sources, such as gifts or inheritances. Every dollar you save now will make it that much easier for you to afford the expense when the tuition bill does arrive.
What Type of Account Should I Open?
The most common types of accounts used for this purpose are UTMA accounts and 529 College Savings Plans (there is one more called a Coverdell Education Savings Account that has limited application, but is very useful for families with lower incomes that want to save smaller amounts).
A UTMA account is simply an account that you open in your child’s name, which can be invested in almost any manner, and can be used for any purpose, so long as it is for the benefit of your child. The main drawback of the UTMA account is that once you contribute funds to one, you cannot remove the funds again and spend them on anyone other than your child. And when your child reaches the “age of majority” (21 in most states) he or she is officially in control of that UTMA account whether you like it or not, and can spend the money as he or she wishes.
A 529 College Savings Plan remains in your control, thus avoiding the main drawback of the UTMA account. It also allows your investments to grow tax-deferred, and you can make withdrawals free of tax as long as you use them for higher education expenses, which is another added advantage over the UTMA. You can always transfer balances among beneficiaries, so if you have a 529 plan for a child that does not use it, the money can be used for another child’s education, and if necessary, the money can be removed, but then taxes plus a 10% penalty may apply.
While the UTMA account and the 529 College Savings Plan are two of the most common tools for saving for education, there is nothing preventing you from using regular savings or investment accounts in your own name for this purpose, and some families may prefer the flexibility this affords. A simple bank account or brokerage account is perfectly adequate for this purpose if you prefer flexibility and simplicity above all else.
How Do I Avoid Riba and Other Prohibited Investments?
Muslim investors may wish to avoid interest-based investments, such as bonds, when saving for college. All the college savings options mentioned above offer the flexibility to do this, but it is important to communicate to your financial institution that you wish to avoid owning bonds or other interest bearing securities in your portfolio.
It is critical to understand that taking this step, while it is clearly advisable from an Islamic point of view, can greatly increase the volatility in your investment portfolio. Therefore, Muslim investors who avoid bonds should make sure they understand the potential risks of investing without bonds, and ideally they will have a long time horizon before they will need to withdraw their investment- typically 7-10 years or more.
Another consideration for Muslim investors may be to avoid exposure to investments that benefit from un-Islamic business activities, such as the sale of alcohol, pork products, gambling entertainment, and other similar vices. This is difficult to do within 529 College Savings plans, since each company offers only a limited number of investments, and very few currently offer investment products of this nature. It is easier if one chooses to use an UTMA account or individual investment account, as many more investment options- including a number of “Islamic” themed investment products- are often available.
What Do I Do If There’s No More Time to Save?
College is almost unanimously regarded as important by most families, but many are starting to adopt a pragmatic approach towards budgeting for it, as opposed to the “spare no expense” mentality that was more common in the past.
For instance, as readers would have noted above in the “costs” section, there is a huge range of prices. Many of the more expensive schools in the country are relatively mediocre in terms of their academic reputation, and yet some of the top schools in the country are on the lower end of the cost spectrum, especially public universities at which you qualify for “in-state” tuition rates. Unless money is truly no object for your family, you and your child should have a very good reason if you’re going to pay the rates of higher cost private schools. Simply choosing to attend a public university over a private one can cut your costs by half.
It is also important to understand that while the “sticker price” of college may be high, there are often many financial aid programs that your family may qualify for that can reduce the sticker price dramatically. The way to see if you’re eligible for aid programs is to fill out the “FAFSA” form (you can find it at www.fafsa.ed.gov), and according to a recent article by USA today, “unless you’re reading this from your yacht,” everyone should fill one out. Though it’s never guaranteed, many families who did not think they would be eligible end up qualifying for grants and loans, and some of the loans may even be interest-free for a time, which is of course an added attraction for Muslim families.
Finally, an interesting strategy that is becoming increasingly popular is taking a “gap year” before starting college- in other words, taking a year off to work. This strategy has several advantages. The family gets an extra year to save, and the student can contribute to savings by contributing his or her earnings during the year, which could easily mean an additional $15,000 or more. Depending on how effectively your child uses his time during the gap year, it may improve his resume when applying to colleges; and the extra year of maturity may make him more likely to succeed in his studies when he resumes, and possibly give him an advantage in applying for jobs when he graduates.
* College cost information obtained from Peterson’s, part of the Thomson Corporation.
Required Disclosure: Access Wealth Planning, LLC is located at 4 Becker Farm Road, Roseland, NJ 07068, 973-740-2400. Investing involves risk including potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. a 529 Plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. Every state offers at least one 529 plan. Before buying a 529 plan, you should inquire about the particular plan and its fees and expenses. You should also consider that certain states offer tax benefits and fee savings to in-state residents. Whether a state tax deduction and/or application fee savings are available depends on your state of residence. For tax advice, consult your tax professional. Non-qualifying distribution earnings are taxable and subject to tax penalty.