Deferred Tax Plans Can Help Avoid Interest-Based Financing
By Fatima Iqbal
May/Jun 25
Studying and attaining knowledge is a form of active participation in Islam. As the Quran states, “They could devote themselves to studies in religion, and admonish the people when they return to them – that thus they (may learn) to guard themselves (against evil)” (9:122).
There is no denying that college degrees have long played a crucial role in opening doors to opportunity for many Muslim families. However, with increasing workforce competition and unprecedented economic pressures, the pursuit of higher education has become costlier than ever before.
For Muslims, attaining a degree in higher education can become even more challenging as they try to navigate away from riba (interest-based) loans in an attempt to decipher the halal and haram aspects of financial aid packages.
Most college students rely heavily on riba-based loans, including private and subsidized student loans. For Muslims, it is our responsibility to protect our families from the dangers of riba and find meaningful ways to invest for our children’s education outside of the interest-based loan system. Grants, work-study, deferred interest loans (if paid before graduation), or gifts from grandparents and relatives may provide students with some financial help. However, these options may still not cover the entirety of the costs. Saving and investing are therefore at the heart of any successful college financing plan.
Understanding How Much to Save
For decades, college costs have risen faster than inflation, and this trend is expected to continue. Annual college costs are expected to increase at a rate of 3 to 5% per year. As a result of these increases, average annual costs are estimated to reach as high as nearly $100,000 for private colleges and $47,000 for public in state schools by the 2033-34 school year.
There are several considerations that will influence the total amount required to fund your child’s college education. First, consider the type of school they might attend. Will it be a public or private institution? Do you want to save for 2-year, 4-year or graduate level degrees? Regardless of whether your child is old enough to have a plan for their higher education, it’s important to set a realistic and attainable financial goal for their educational future.
As such, it may be worth asking yourself, “How much education would I ideally want to pay for my child?” Second, consider your child’s cost of living during college. Their living costs could vary substantially based on whether they live at home, on campus, or in off-campus housing. Finally, it is important to consider the number of years they have left before they start college. The more time they have before college, the more opportunity there is to save and invest. College savings calculators can be a very helpful tool to understand how much you should save based on your child’s age and goals.
Next to buying a home, funding a college education is often the largest purchase that parents make for their children. The key to overcoming such a daunting task is to start early and take small steps towards this financial goal.
- Regular and recurring contributions can go a long way toward saving for a major purchase like college. By automating your savings, your money can work for you gradually over time without the psychological stress of making large lump sum deposits. Review your budget and set up manageable, recurring, and regular contributions to your child’s education account. Monthly contributions reformulate the price of college into bite-sized monthly “payment amounts.” In doing so, the cost of a $200,000 education becomes more attainable when saving and investing gradually over many years.
- In addition, starting to save early maximizes the amount of time you have to invest, giving you as much time as possible to build up returns in your child’s college fund. It’s best to open your child’s account as soon as they’re born but it’s never too late to start.
- College Savings Vehicles are accounts geared towards saving for college education. Many of them offer benefits to reduce tax on money put away for education. However, these plans each have their pros and cons..
College Savings Plans
529 Plans are a common tax-advantaged college savings option. These are state government-sponsored plans with some states offering state income tax deductions on contributions. 529 contributions also grow tax-deferred, and earnings can be withdrawn tax-free when used for qualified education expenses. However, the biggest drawback of 529 plans for Muslim families is the lack of halal investment options.
UTMA/UGMA Custodial Accounts are a way for your child to hold assets in his or her name with an adult acting as custodian. Assets in the account can then be used to pay for college or anything else for the child’s benefit. All contributions to the account are irrevocable, and your child will generally gain control of the account when he or she turns 18 or 21 depending on your state’s rules.
But earnings and capital gains generated by assets in the account are taxed each year. Under the 2025 “kiddie tax rules” for children under the age of 19, and for full-time students under the age of 24 who don’t earn more than one-half of their support, the first $1,350 of earned income is tax-free, the next $1,350 is taxed at the child’s rate. Anything over $2,700 is taxed at the parent’s rate.
While UTMA/UGMA Custodial accounts do not offer the same tax benefits of 529 plans, you can select halal investments that have more flexibility for uses other than just education. For example, if your child does not use the account for education expenses, they can use it for future wedding expenses, buying their first home, or starting a business. UTMA/UGMA Custodial accounts can also have a larger impact on your child’s eligibility for need-based financial aid.
Coverdell Education Savings Accounts are accounts named for their primary champion in the United States Senate, the late Paul Coverdell (R-Ga.). These unique savings vehicles allow contributions up to $2,000 per year per child. The money grows tax-deferred, and earnings are tax-free if the money is used for qualified elementary, high school, or college expenses. With Coverdell, you can invest in the full marketplace of halal funds and investments. However, individuals with incomes over certain thresholds may not be eligible to contribute and not all national brokers offer this type of account.
Planning for the Future
Establishing a college savings plan for your children while they are young can help cover educational expenses and minimize their reliance on interest-bearing loans. More importantly, it is an investment in your child’s future helping them to achieve one of the most valuable assets they can have – an education.
Parents must prioritize their retirement savings as well in order to avoid placing a financial burden on their children down the line. Remember, there is no financial aid or federal grants available for retirement. While parents may be able to tap into retirement savings in an emergency, it’s best to have a well-thought-out plan in place. Consider working with a financial planner who can help you balance these competing priorities while creating a customized plan that supports all your financial goals.
Fatima Iqbal, CFP, is senior investment strategist and financial planner with Azzad Asset Management, Inc.