Smart Ways To Set Up A College Fund For Kids
A college education is one of the main ways many of us aim to give our children every advantage in life. However, with higher education expenses reaching new highs year after year, its increasingly important to save for their college expenses and do so in the most effective ways possible. Here are some smart ways to do just that. Consider working with a financial advisor as you seek to build up funds for higher education.
Where To Find The Money To Save
The final major challenge I hear from parents too often is how can I even save for college for one, let alone two/three/etc. Look, finding money to save for college is tough. Thats why I highly recommend starting small when saving for college. You really dont need to find huge amounts to get started.
My single favorite strategy for saving for college is asking friends and family to provide a contribution to the 529 in lieu of gifts for birthdays and Christmas. Parents love to give toys and junk because they are a little selfish they want to see the kids happy with the gift they gave them.
Our rule is that grandparents are only allowed to give one toy or gift. The rest should go to the childs 529. That way, grandparents can still get some joy of the child opening a gift, but they are also helping save for college down the road. Plus, every parent realizes that their child doesnt need 10-15 new toys every birthday and holiday. Most of that goes to waste.
Where To Save For College
For many people, the easiest and most convenient way to put money aside for college is through a state-administered 529 college savings plan, also known as a qualified tuition program. The money you deposit in a 529 college savings plan grows free from federal income tax, and your withdrawals are also tax-free as long as you use them for qualified higher education expenses, such as tuition and room and board.
Another type of 529, a prepaid tuition program, covers tuition but usually not room and board. Many states also provide for tax-deferred growth and tax-free withdrawals, as well as allowing a state tax deduction for the money you contribute, up to certain limits.
There are no limits on how much money you can add to a 529 plan each year, although many states do set limits on total contributions. Recently those ranged from $235,000 to over $500,000which, for people who can afford to save that much, could be ample to cover just about any four-year degree.
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How Much Should I Save For My Childs College Education
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Its no secret that the cost of higher education is continuing to rise. According to Education Datas research, the average cost of college tuition in the U.S. is $35,720 per student per year.
As if that werent enough, college costs increase at an annual growth rate of 6.8%. To put this into perspective, the average interest on a savings account is 0.05%. Yikes!
Parents have multiple financial goals to juggle. From paying off the mortgage to saving for your retirement, there are several things that take priority. Still, its smart to think about your childs college education expenses before that bill comes due. By planning ahead, you can continue to set your child up for success without breaking the bank.
Save In The Right Place
Now, people often ask where to put the money theyre investing for their kids college. The two most common options are the 529 plan and the ESA .
These two options are similar in one important way: The money in the accounts grows tax-free and isnt taxed when its taken outas long as the money is used for qualified expenses.
Heres the bottom line: You want to stay in the drivers seat with your money, whether its in a 529 plan or an ESA. If you go with an ESA, you have more control over how you invest it, but 529 plans are beginning to offer more flexibility. Here are the account features at a glance:
529 Plan
- Contribution limit of $2,000 per child/year
- Nonqualified withdrawals are taxed
Whatever you do, dont go with a prepaid tuition plan. There are lots of restrictions involved, and over the long haul, youd get more bang for your buck by investing that money instead of locking in a tuition rate. Trust us, just dont do it.
P.S. Before you start saving, talk with a financial pro in your area about which plan is best for you.
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What’s The Best Way To Start Saving
But while you can breathe a little easier, that doesn’t mean you’re completely off the hook: Financial planners advise socking away money for your child’s education as soon as you can — even if it’s only $20 a month. To get started, open a college fund for each of your children. Having a dedicated account will put you in the mind-set of saving and will ensure that you have a place to add extra money that you might hope to see in the years ahead. “The sooner you start saving, the more time your funds will have to grow. And the more money you have, the more choices your child will have when it’s time for him to head off to college,” Munro says.
Simple College Savings Tips For Students
College is a privilege. Sure, most of us want our kids to pursue a degree, but that doesnt mean its our responsibility to pay for it. Its totally okay for them to take some ownership in their education. Even though your child is a full-time student, theres no reason they cant start building up their own savings fund. At the very least, doing this will help establish healthy money habits theyll carry into the future.
Here are some great college savings tips to help them get started:
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Additional Ways To Save Money For College
Sticking with college, here are additional ways to save that you and your child can work toward. Whether youre a new parent or a year out from sending your kid off to college, consider these opportunities to save money.
And, mom and dad, when the time comes, make sure you fill out the Free Application for Student Aid .
How Much Do You Need To Save For College Expenses
This calculator is designed to help you create the most effective funding strategy to cover your expected college costs using a 529 plan. Note that attendance costs and scholarship availability can vary considerably from school to school. The Worlds Simplest College Cost Calculator allows you to estimate costs based on school types .
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How Much Do I Need To Save
Many parents are in a very tight cash flow situation in the first few years of a childs life, as they are often going from two incomes to one income, said financial planner Julia Chung. The savings need to be reasonable given the individual situation.
The Scotiabank survey found that parents and guardians in Atlantic Canada estimated the average total cost of a post-secondary education for their child, including tuition fees, housing, and other expenses, will be a whopping $110,435 while those in Quebec say they estimate the cost will only amount to $33,738.
Moran said how much parents or guardians need to save these days in order to be able to afford a post-secondary education for their child really depends on several factors.
Some of these factors include:
- Where will the child attend post-secondary school? Note: tuition fees vary from province to province
- What type of post-secondary institution the child will attend?
- How long they will attend?
- Will the child live at home while they study?
- How will tuition costs change?
While experts say its difficult to say how much a child should have in the bank at the start of post-secondary, online resources, like this RESP savings calculator, give parents a rough idea of how much an education might cost.
The tool allows you to choose the province of study, the number of years your child is expected to study, the current tuition value and whether the child will live away from home.
Dont Forget About Scholarships And Grants
For a lot of Americans, thinking about the cost of college is stressful. And if youre in that boat, you might be forgetting about a little ray of sunshine called scholarship and grantsalso known as free money.
But heres the catch: You have to complete the FAFSA every yearand every state has its own deadline for completion.
The FAFSA is used to figure out how much you can get in federal grants and state grants. Even if you think you make too much money, do it anyway. Many colleges, foundations and corporations use it to award scholarships.
Filling out the FAFSA probably isnt how youd like to spend a rainy afternoon, but if you dont, you might be leaving cash on the table. A third of undergrad students dont file the FAFSA, and of those, 2 million would have qualified for a grant!5 Spending a day filling out these forms sounds worth it now, doesnt it?
In addition to grants, you need to go after all the scholarships you can. We repeat: all the scholarships. And in todays digital age, apps like Scholly and websites like CareerOneStop make finding and applying for those scholarships much easier. So, theres really no excuse for not going after every penny you can find.
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Work With An Investment Pro
Ready to start investing for your kids future? Get the help of an experienced investment professional to walk you through all the options. Our SmartVestor program can connect you with a trustworthy pro who can help you reach your investing goals.
About the author
Ramsey Solutions
Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.
Types Of College Funds For Kids
College graduates are at a disadvantage these days. Before they can even get out into the workforce, theyre slammed with thousands of dollars in student debt. As a parent or grandparent, you want to give them the best chance to avoid debt or mitigate it at the very least. With the right plan and enough hard work, these college fund options should help:
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Saving Too Much In A 529 Plan Is An Expensive Mistake
529 plans are a great way to save for college. Money is invested and withdrawn tax-free if spent on qualified educational expenses. But if your savings exceed the cost, you may have to pay tax plus a 10% penalty on what’s leftover. Given the uncertainty of college costs and investment returns, trying to cover exactly 100% of expenses with a 529 plan is practically impossible. Sure, your kid may decide to continue their education after graduation…but how many seven-year-olds really know they’re going to become a doctor? And saving any amount for college before having children is too much.
Like retirement accounts, 529 plans have tax advantages. But qualified accounts effectively lock the money up, forcing you to pay a penalty if you need it for something else other than education.
How to fix it
- Consider funding your kids’ 529 plan with no more than 75% of the savings goal. Pay for the rest by investing the rest in a flexible brokerage account or out of cash flow.
- If you’ve already saved too much, you still have options. When your child finishes college, you can name a new beneficiary, such as another child or a relative. If the graduate is considering an advanced degree, you may want to take a wait-and-see approach. In the event an older child took out student loans, up to $10,000 from a 529 plan can go towards repayment.
- Sending your child to private school? You may be able to use up to $10,000/year to pay tuition for K-12 education.
Financial Planners Recommend Investing Through A 529 Plan
To be sure, the typical American parent isn’t covering the entire cost of a college education for their child or children. Most families finance school with a mixture of savings, income, and financial aid. Nonetheless, these calculations show what is possible with compound growth.
Many financial planners recommend opening a 529 plan to put away as much as possible for college. As evidenced by the calculations above, the earlier you begin, the less money you need to invest.
529s are state-sponsored, tax-advantaged investment accounts in which the money grows completely tax-free and can be withdrawn tax-free at any point, so long as it’s used to cover college tuition, housing, fees, books, and supplies. 529s can also be transferred among children if one needs more or less money for college than initially expected.
Annual contribution limits for most 529 plans are high, starting at $235,000 in some states. However, any contribution made in a single year above $15,000, or $30,000 for married couples, will incur a gift tax. A parent or grandparent may also front-load the account with up to $75,000, or $150,000 for married couples without incurring a gift tax, though they won’t be able to contribute for another five years.
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Can You Help With Tuition Without Compromising Your Finances
Parents have only a finite amount of money, and if it comes down to a choice between investing in a college savings account or investing for retirement, you need to choose investing for retirement every time — even if this means you wont be able to help your kids at all.
Social Security alone isnt enough to live on and most people dont have guaranteed pensions from employers to provide supplementary income, so you must have retirement savings. Your children can borrow for college costs, but you cannot borrow to fund your retirement when you get into your 70s and have no money. And dont assume you can just keep working longer to save, as many people end up having to leave work before they planned because of health issues or challenges finding a job in their 60s.
If youre thinking about borrowing to help your kids, youll also need to consider what that will do to your finances. Will you be able to keep saving for retirement while paying on the loan? Could you afford to pay off the loan if you had to retire early? And dont forget, the student loan shows up on your credit report and affects your debt-to-income ratio. So if you borrow, you might not be able to qualify for a mortgage if you must downsize or may not be able to get approved for a loan for your second child if you borrow too much for your first one.
How Much Will Your Childs College Cost
The cost differences between public and private schools can be significant. The College Board estimates the current yearly cost of a public 4-year college at $22,1803 versus $50,770 for a 4-year private college.4
Our 2K rule of thumb assumes the student is attending a public 4-year college using the College Board estimate: $22,180 per year for 4 years, though the college savings calculator allows you to create a customized estimate if your costs are different.
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Best Ways To Save For College
Instead of saving in a traditional bank account, there are plenty of options for investing your money so you can take advantage of compound returns. An important college savings caveat is that, depending on the strategy you use, investment earnings will add to your total savings.
A 529 plan, for instance, is a tax-advantaged education investment account that individual states offer. Some states give residents a tax break for using their home account, but you can choose any plan you like. As you would in a 401 or an individual retirement account, you can typically choose your own funds to invest in or opt for a mix of funds targeted toward your childs anticipated college start date. That will ensure your investments arent too risky or too conservative.
If you save each month in a 529 plan, you could contribute less per month and save the same total amount when your child goes to college. In our example from above, youd have to save $209 per month for 13 years to reach about $44,000 in savings, if your investments receive a 6% average annual returna reasonable goal based on historical stock market returns. Thats about $96 less per month than if you didnt invest your money.
Prioritizing College Savings Over Your Retirement Sets The Wrong Example
Parents can be pretty selfless when it comes to their kids. But it’s important not to sacrifice your own financial health in the process. After all, there are no loans for retirement. Saving for the cost of a four-year college education is challenging, but nowhere near as hard as paying for 30 years of expenses in retirement. If you get too far behind, there isn’t always time to catch up. You can only spend a dollar once and over-extending to help your student may mean you’ll be the one needing help down the road.
Also, kids learn about money from their parents, so it’s essential to set a good example. Getting behind on your bills to pay tuition or putting your retirement security in jeopardy to afford something out of reach may send the wrong message. Make no mistake: education is really important, as is helping your children secure their own financial future. But depending on your financial situation, it may not be realistic to give kids a blank check for college. And it does nothing to teach kids about evaluating cost-benefit trade-offs, sticking to a budget, or living within their means.
How to fix it
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