How to Pay for College with Stock Options

by | Apr 13, 2018 | Financial Independence, Stock Options

How to Pay for College with Stock Options

by | Apr 13, 2018 | Financial Independence, Stock Options

how to pay for college with stock options college savings

You know that education is important. You’re probably better educated than your parents — and your great income and stock options are both a product of that education.

But you also know that the cost of an education will likely only increase. In fact, according to College Board, tuition and fees at public four-year universities for the past decade has grown at an average rate of 3.2% beyond inflation each year.

There’s also less good information out there around college planning as compared to retirement planning, which presents even more of a challenge for parents wanting to figure it out.

Here’s the good news: your equity can help. Here are a few ways to think about how to pay for college with stock options.


First, Know How Much College Will Likely Cost

The first step in determining how to pay for college with stock options is to quantify the price. After all, you need to know just how much cash you’ll need to cover the expense.

You can look up specific costs by researching individual colleges, you or can get a ballpark estimate of tuition and fees plus room and board for several different types of colleges.

Right now, the total cost for a public four-year university with in-state tuition is about $20,770 for the 2017-2018 year. But consider how old your children are and how much college costs will be by the time they go to school.

You can use this college savings calculator from to estimate future costs based on your own assumptions. With the total cost in mind, you can then estimate how much to set aside now to pay for college with stock options.

For the sake of this post and giving clear examples, we also drew up a report on what it might cost to send your 5 year old to Stanford in the future. You can check that out here.

Once you quantify the future cost and the amount to set aside now, you can determine if you expect—given your current wealth—to be able to simply pay for it. In other words, can you just write the check when the time comes?

This may work well if you have high schooler or teen about to go to college, and have no time for the benefits of a 529 plan to accumulate.

Regardless of your child’s age and the time remaining before college, you’ll need to convert your stock options into dollars that can be used to fund college. That means you need to prioritize the source of those funds from stock options.


Different Strategies to Consider If You Want to Pay for College with Stock Options

Depending on the type of stock options you have, you may have a different strategy. Here’s a quick breakdown of each:

Restricted Stock Units (RSUs): RSUs are taxed just like your salary as soon as they vest, so there is no tax advantage to holding onto an RSU. Sell them to get the cash.

Employee Stock Purchase Plan (ESPP): An ESPP allows you to purchase company shares at a discount. You can sell your shares immediately to capture the discount, but your return will be taxed as ordinary income.

If you instead hold onto your shares for more than one year after the purchase date and more than two years after the beginning of the offering period, any gains you earn beyond the discount will be taxed as long-term capital gains.

Non-Qualified Stock Options (NQs): Since there’s no special tax benefit with NQs, simply hold onto yours until their expiration date or you need the funds. Exercise them and execute a same-day sale.

Incentive Stock Options (ISOs): ISOs offer the biggest tax advantage of all. As long as you sell your ISOs at least two years after they were granted and at least one year after you exercised them, your gains will be taxed as long-term capital gains.

Coordinating your ISOs with your other stock options (i.e., RSU, ESPP, NQ) will give you the best shot at capturing all the benefits.


What to Do with Cash from Stock Options

Depending on your child’s age, you can invest the dedicated funds through a college savings account. There are 3 main types to think about:

  1. Coverdell Educational Savings Account (ESA)
  2. 529 College Savings Plan
  3. 529 Prepaid Tuition Plan

ESAs and prepaid tuition plans are generally less flexible than the 529 College Savings Plan. Of course, there are situations in which you might want to use them. If you think these might be good options, talk to a financial planner who can help you compare the different scenarios.

For most people, a 529 College Savings Plan is the best way to save and invest dedicated dollars for college.


529 College Savings Plans: The Basics

A 529 College Savings Plan allows you to invest your college savings on a tax-deferred basis. When it comes time to withdraw the funds to pay for college, withdrawals for eligible expenses such as tuition, fees, books, and room and board, are tax-free.

If you withdraw the money for other purposes, though, there’s a 10 percent penalty and your gains will be taxable.

Here are some other highlights you’ll want to know:

  • Contributions do not qualify for a federal tax deduction. A 529 plan differs from a 401(k) in this way.
  • Depending on where you live, your contributions may qualify for a state tax deduction or credit. You typically have to live in the state and use the state’s 529 plan to get the tax break.
  • You’re not required to use your state’s plan, so if you live in a state that doesn’t offer a tax break, you can shop around to find a plan with the lowest fees and best investment options.
  • There are no income limits, and you can contribute up to the amount necessary to provide your child with an education. Limits vary by state.
  • You can change beneficiaries if needed.

The Tax Cuts and Jobs Act that became effective January 1, 2018, makes 529 plans even better for those wanting to save and pay for the costs of education. According to the new law, you can also use 529 plan funds for private K-12 education and have up to $10,000 in tax-free withdrawals per year.


Before You Just Pay for It, Consider the Tax Advantages You’ll Miss

If you have the money, simply paying for college may be the simplest approach. But it leaves you exposed to taxes, including federal taxes, dividends and interest, capital gains, net investment income, state taxes.

And taxes are like wear and tear that drag down your investment returns. They’re something you want to avoid or minimize if you (legally!) can.

Remember that report from above? It told us you’d need to invest $145,000 right now for your five-year-old to attend Stanford.

$145,000 assumes that you can invest that amount at an average annual return of 8%. But is that before or after tax?

Assuming that you end up in the top rate of 23.8% on capital gains and qualified dividends, you would need to invest that $145,000 at 10.5% average annual rate of return to net 8% after taxes.

With the belief that risk and return are related, a 10.5%rate of return before tax in a brokerage account means you risk more to achieve it than you would need to take if you just looked for an 8%, which you could do with a tax-advantaged 529 plan.


One Last Argument for Using a 529 College Savings Plan as Part of a Dollar Location Strategy

You may be dealing with lots of dollars in the form of stock options, especially if your company went through an IPO or you’re a highly compensated employee or executive.

If this describes your situation, you need to answer a key question: Once I exercise and sell my options, where should I put the resulting dollars?

There are 3 types of accounts to put your money in: taxable, tax-deferred, and tax-free.

A 529 plan is either tax-deferred or tax-free. It’s tax-free if you use the funds for college or private school. It’s tax-deferred if you use the funds for something else.

Tax-deferred, on paper, is not as beneficial as taxable. A lower capital gains rate appears to beat the income tax rate plus 10% penalty on disqualified withdrawals from a 529 plan.

With a taxable account, you pay tax on dividends and interest every year, with little control or influence on timing. Capital gains are paid when you sell an investment., giving you less control or influence.

With a 529 plan, taxes are only owed if you withdraw money for something other than college or private school. With the ability to change beneficiaries, you have great influence and control over when and if this happens.


How to Think About a 529 Plan as Part of Your Overall Financial Plan

Consider how much money you have and if your financial priorities are funded. Are there gaping holes in your plan that you need to account for first? This might be something like repaying debt, buying a house, or reaching your goal of financial freedom.

Your cash from stock options may be more appropriately put toward these goals rather than your child’s college fund.

Next, consider maxing out possibly more advantageous accounts, such as your 401(k), HSA, or your after-tax 401(k). These are priorities over college savings, because they’ll help you keep more money in your pocket — and they’ll ensure your future financial security.

Checking off these boxes and still have money left over? We’d argue a 529 plan might be the best place to allocate dollars to pay for college.