Start Saving For College Asap
You want to start saving for college when your child is still young. Kantrowitz recommends saving about one-third of future college costs. “Like any major life-cycle expense, the costs will be spread out over time,” says Kantrowitz. “With about a third coming from past income , a third from current income, and a third from future income .”
Based on current costs, you should save $250 per month for a child born this year who will attend an in-state public college, $400 per month for out-of-state, and $500 per month for a private college. Start the college savingsand the conversationearly so you and your child can make the best academic and financial choice for their future.
Choose A Savings Plan
There are a ton of savings plans to choose from, and its important to understand the implications of each, and what it can mean for your childs future.
When thinking about how much to contribute to whatever plan you choose, review your cash flow to determine how much you can realistically dedicate to college savings while not disrupting your current lifestyle or saving for other goals, says AnnaMarie Mock, a wealth advisor at HIGHLAND Financial Advisors in Wayne, New Jersey.
This Is The Best Way To Save For College And Hardly Anyone Uses It
For families trying to save for their childrens college education, 529 college savings plans are widely hailed as a great optionperhaps the best. But are they?
The advantage to 529 plans, named for a section of the tax code, is that families can invest through these accounts without the earnings being taxed as long as the funds are used to pay for college expenses. Earnings are typically free from federal and state taxes, plus grandparents, aunts, uncles and anyone else who cares can contribute to the account.
The most popular one operates much like a 401k retirement plan because contributions are invested in stocks, bonds or money market funds. Earnings are not subject to federal taxes as long as you use the money for qualified education expensestuition, books, fees, room and boardat any accredited school.
Yet less than 3 percent of families have tax-advantaged college accounts, according to the Government Accountability Office. Using data from the Survey of Consumer Finances, the GAO figured out that the few families that do have accounts have a median income of $142,400 a year, nearly triple the national median household income.
Families with tax-advantage college accounts also had about $413,500 in assets, making them among the wealthiest group in the countryand the biggest beneficiaries of the $1.6 billion in federal tax expenditures directed at these plans.
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Take Advantage Of The Aotc
The American Opportunity Tax Credit allows you to knock up to $2,500 off your tax bill, per student, per year. It can be applied to you, your spouse, or your dependents. The first $2,000 of your college expenses earn you a dollar-for-dollar tax credit, after which you get a credit of $0.25 for every dollar you spend on tuition, up to another $500 in tax credits.
Keep in mind that a tax credit is far more beneficial than a tax deduction. Deductions come off your taxable income credits come off your actual tax bill. You can find more details about the American Opportunity Tax Credit and other college tax deductions and credits here.
Use A Bank Savings Account
An FDIC-insured bank savings account is one of the safest places to squirrel away money for a child’s future. The problem is, it doesn’t come with many benefits. A regular savings account pays low interest, and what you earn gets taxed as income.
If you have a large amount to save, consider getting a high-yield savings account, which pays double or triple compared to regular savings. However, what you earn is still relatively low compared to other options we’ll cover.
For example, if you save $100 a month for 20 years in a bank account earning 0.25% interest, you’d accumulate less than $25,000. But if you put the same amount in high-yield savings making 2%, you’d have almost $30,000 after two decades.
If you’re like Heather, you might consider opening a CD with a bank or other financial institution for even higher returns. CDs can be FDIC-insured, and they’re also extremely safe.
With a CD, you loan money to the institution, which lends it to their customers, and you receive a set rate for a period, which is called the term. CD terms can range from a few months to a few years. In general, the longer the term, the more interest you receive. When the term is up, you receive your initial deposit plus any interest accrued.
Heather wants to know if she should add money to her 12-month CD when the term is up or get a new CD. In general, traditional CDs do not allow you to add money after your initial deposit, so she’ll need to open a new CD.
Pros and cons of bank savings accounts
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Education Savings Account Or Education Ira
An ESA works a lot like a Roth IRA, except that its for education expenses. It allows you to invest up to $2,000 per year, per child. Plus, it grows tax-free! If you put away $2,000 a year starting when your child is born, by the time they turn 18, you would have invested $36,000. Its hard to say exactly what the rate of growth is with an ESA because it varies based on the investments in the account. But at the average stock rate of 12%, that $36,000 would grow to around $126,000 by the time the child starts school. Congratulations, you more than tripled your investment, and now Junior doesnt have to worry about paying for tuition!
We like the ESA account because its likely a much higher rate of return than youd get in a regular savings accountand you wont have to pay taxes when you withdraw the money to pay for education expenses. An ESA isnt just for college tuition either. It can be used for K-12 private school tuition, vocational school or things like textbooks, school supplies or tutoring If your child doesnt end up needing it, you can transfer the money to a sibling for their school.
Why We Like It:
- Higher rate of return than a regular savings account
Why We Dont:
- Contributions are limited to $2,000 per year
- You must be within the income limit to qualify
- The amount must be used by the beneficiary by age 30
Use An Ordinary Investment Account
One disadvantage of both the 529 and the Coverdell is that if your child ends up not needing the money for educational expenses, theres a tax penalty for non-educational withdrawals from the account. Using an ordinary investment account gets around this you have to pay taxes on all investment gains, but you dont have to pay an additional tax penalty if the money isnt used for educational purposes.
This is a good option if you want to be able to hedge your bets down the line, but it comes with a big disadvantage. If your student is applying for more financial aid using the FAFSA, assets in an ordinary investment account will have a negative impact on the student loans and grants theyll be able to get. This means that they may have to rely more on private student loans, which may have higher interest rates and stricter requirements.
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How Much Should You Save
As you might imagine, the answer to this question will be different for everyone. I’ll talk about the costs of college, how they’re expected to change, and some common savings goals before moving into the nitty-gritty of savings calculations.
College is already pretty expensive, with costs varying based on factors like school type, financial need, and academic merit. On average, it costs about $45,000 to attend a private US college for one year, while the cost of attendance at an in-state public school averages about $23,000. You can read more about estimating your own expenses with our college cost guide.
Although it’s currently pricey to get a college education, expenses are only increasing year by year. If prices increase at a rate of 5% annually, the total cost of 4 years of college in 18 years could be:
- $237,000 at an in-state public university
- $464,000 at a private college or university
These sticker prices are definitely intimidating, but it’s important to keep in mind that most families aren’t shelling out those total amounts in cash in order to pay for school. As of a few years ago, this was the average percentage breakdown of how families paid for college :
- 5% contributions from relatives and friends
- 9% parent borrowing, like with a private or PLUS loan
- 18% student borrowing, like with a Direct loan or Perkins loan
- 27% parent income and savings
- 30% grants and scholarships like the Pell Grant
The Best Way To Save For College If Youre Struggling Financially
If you have major debts that go to collection or if you have to file for bankruptcy, your childâs 529 education savings account should be largely protected, with a few exceptions. Contributions made in the last year arenât protected from bankruptcy proceedings, and thereâs a cap of about $5,000 on exempt contributions from the year before. Beyond that, though, creditors generally cannot touch your childâs 529 funds.
Most statesâ 529 savings plans are available with either no minimum contribution or a low minimum contribution . So even if money is tight, getting started on college savings is likely an attainable goal. Whether youâre putting away $50, $150 or $1,500, the most important thing is to figure out a plan that fits for your family.
My own lesson from this? Donât get scared off by college âsticker shockâ or headlines about rising tuition costs. Instead, concentrate on making consistent, affordable contributions and aim to cover a reasonable portion of college costs. Time is on my side, and every baby step brings me closer to a bright future for my child.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
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Evaluate Alternatives To 529 Plans As You Save For College
There are a lot of college savings options. But personal finance is personal, and using a certain account to save for college may make sense depending on your specific situation.
If you decide to turn to alternatives to 529 plans, consider consulting with a financial advisor who can explain the pros and cons of any option you consider. Ultimately, your best bet is to avoid regular savings accounts and CDs because the interest rates are typically very low. With other 529 alternatives, however, you can put your money to work and potentially earn a return by investing your savings instead.
If youre saving for a childs education and have a time frame of five to 18 years before those funds are needed for college, investing in a 529 plan, Roth IRA or brokerage account can help you maximize the cash you set aside for those future expenses.
Whichever method you choose, be sure you take the time to fully understand how your decision will affect your full financial future in the long term. Save successfully, and your family may be able to avoid federal and private student loan borrowing.
Andrew Pentis and Emilia Benton contributed to this report.
Where To Find A 529 Plan
Youâre generally free to open a 529 in any state, not just your home state, although there may be tax benefits for going with your stateâs specific 529. SavingForCollege.com offers a comprehensive listing of 529s across the country, along with reviews.
What you can do today: Create a calendar alert to sit down and spend a couple hours researching various 529 or other plans, and open an account. Trying to do everything all at once can be overwhelming, so you might choose a time when you know youâll be unhurried and can really do it right.
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Investing For Your Childs College Education
A recent survey shows that 84% of millennials are saddled with some sort of regret over their student loan debt, many of them wishing they could hit the rewind button and do things differently.1 If youre interested in saving for your kids college so they dont experience the same frustration, you have some tax-advantaged college savings options similar to your retirement accounts.
An Education Savings Account is a great place to start! Theyre simple and are similar to an IRA, but there are a couple limitations. First, the maximum you can invest in an ESA is $2,000 a year. And second, married couples making more than $220,000 a year and single parents bringing in more than $110,000 a year cant make contributions to an ESA.2
If you want to invest beyond the $2,000 limit or if your income exceeds the ESA income limits, you can put some extra dollars in a state-specific 529 plan.
Saving for your kids college fund and making sure they make a smart school choice can help them avoid a future filled with student loan payments. Theyll thank you later!
When Is The Best Time To Invest Money For College
College is an investment, and it can be a pricey one. By saving early , you can earn a bigger return on your money down the line.
With that said, dont let getting started later deter you from saving at all. Its kind of like the Chinese proverb, The best time to plant a tree was 20 years ago. The second best time is now. You want to save what you can as early and regularly as possible. But if life circumstances prevented you from doing so before, right now is the next best time to start saving.
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Get A Life Insurance Policy
An often-overlooked way to protect a child’s financial future is to purchase life insurance. It’s a contract that pays one or more beneficiaries after the policyholder’s death.
An often-overlooked way to protect a child’s financial future is to purchase life insurance. It’s a contract that pays one or more beneficiaries after the policyholder’s death.
There are two main types of life coverage, term, and permanent policies. A term policy pays a cash benefit if you die within a period of 10 or 20 years. And a permanent policy covers you no matter when you die, and it may also accumulate a cash value. You can tap the accumulated value or allow it to grow for a child.
If you’re relatively young and healthy, a $500,000, 20-year term life policy may only cost less than $20 per month. It’s wise to cover both parents, especially if one is an at-home caretaker. If a stay-at-home parent dies, the cost could be significant.
If you get life insurance through work, it may not be enough. Most companies offer coverage in an amount equal to one or two times your annual salary. Depending on your financial needs and family size, having life coverage in an amount equal to ten times your income is a good rule of thumb.
Communicate With Your Kids
Its important to let your kids know what you are and arent, willing to do for college. Making those decisions early on will allow your child time to mentally and financially prepare.
Determining how much you agree to pay for your childrens college years is an essential first step. Take the time to figure out inflation-adjusted public and private school tuitions for the years theyll attend school.
This will help you think through some basic questions
- Are you willing to pay for the best school your child is accepted to, no matter the cost?
- Do you want your child to shoulder some of the financial responsibility?
- How do you feel about student loans and debt?
- How do you feel about community colleges?
Another option is to determine a figure youll set aside to pay for their college years first. And then offer your child the choice of how to use the money.
If they choose an expensive college costing more than what youll contribute, theyll need to make up the difference. If they select a path costing less than what you are willing to pay for them to earn their degree or start a successful career, they get to keep the difference.
These are just a few ways parents can begin thinking about the challenge of funding higher education costs for their children.
Its important for parents to communicate college costs clearly and to help teens understand interest rates and payments on large loans they may need or want to take out to attend college.
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How To Save For Your Kids College Without Ignoring Retirement
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Saving for both college and retirement is a daunting task and can involve some hard choices. To get it done, financial advisors recommend these three key steps.
What Are The Tax Benefits
The money in a 529 education savings account grows tax-free. So when your child withdraws the money to pay for qualified education expenses, no federal income taxes or in many cases, state income tax will be due.
The same thing goes for a 529 prepaid tuition plan. You fund the account with after-tax contributions, and no federal income tax or state income tax is owed when your child withdraws the money to pay for college.
But, unfortunately, contributing to either type of 529 plan may not help you save much money on taxes next April. You cant deduct contributions from your federal income taxes, but you might be able to earn a state tax deduction, depending on your state.
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