How To Save For Your Child’s College Education: A Primer
Figuring out how to save for college can be a daunting task because who knows what it’ll cost when that day comes and where — or if — your child will even want to go.
Whether college is far off in the distance or fast approaching, it’s important to be educated with all the options for how to start saving for college so you can make the best decisions. Because it’s very likely that the method that’s right for a well-meaning friend isn’t going to be the method that’s right for you.
From when to start, to how much to save, and where to save it, here’s how to navigate the choices and figure out how to start saving for college.
When should you start saving for college?
You can start saving for college at any time, but, like most things in life, earlier is always better. The most obvious time to start is once your future student is born but you can just as easily open a savings account for them before that.
That being said, don’t panic about college costs and start stockpiling money before you’ve got your own financial oxygen mask on.
Before you start saving for college, it’s a good idea to be rid of your own student loans, have any high-interest debts paid off, establish an emergency fund with three to six months of expenses, and be contributing at least 10 to 15% of your income to retirement.
How much do I need to save for college?
The CollegeBoard’s most recent data for tuition at a public four-year college found it averages $9,410 per year for in-state students. That comes to over $37,000 for tuition and fees alone. When you add room and board and other various expenses, that number jumps to over $100K for four years of higher education. Keep in mind that is on the low end–for public colleges and for in-state students, the costs only magnify when you look at private universities and consider going out of state.
And, by the time your son or daughter is heading off to school, that price will probably be much higher. College tuition has inflated by twice the rate of general inflation over the last two decades.
Thankfully, you don’t have to save thousands of dollars every month to prevent your kid from the student loan burden so many are facing right now. The same CollegeBoard data shows that students rarely pay “sticker price” for school once things like scholarships, and student aid are taking into account.
Check out a college savings calculator which allows you to insert various variables to figure out exactly what you should be saving every month.
What are the best ways to save for college?
With any big purchase, you and your student should first look to get a good deal. That doesn’t mean you should go haggle in the registrar’s office, but it does mean that it is incredibly important to know all of your options for bringing the end price down so you can decrease the total amount you need to save.
If we’re being honest, the best way to pay for college is to let somebody else do it. So applying for scholarships and grants early and often is the best way parents and students can work together to save for college.
Dual Enrollment/ AP Credit
If you find your child has a knack for a certain subject, taking dual enrollment or AP courses in that subject can help lower tuition costs while not placing too much extra stress on their schedule.
Tax-Advantaged Investment Accounts
When it gets down to where to save for college, you don’t want to put your money in a typical savings account earning 1%. There are investment accounts created specifically for saving for college that help contributions keep up with rising tuition costs through tax incentives and growth.
What are the types of college savings accounts?
All of these college savings accounts are easy to open, access, and withdraw from for educational purposes. The ones you choose should be based on your particular situation.
Custodial Accounts (UTMA/ UGMA)
The Uniform Transfer/Gift to Minors Act (UTMA/ UGMA) was the first tax-advantaged college savings program. It allows minors to receive gifts untaxed or taxed at the minor’s tax rate instead of the parent’s.
While other accounts offer better tax incentives, the funds in custodial accounts aren’t restricted to only education expenses. That means the money in these types of accounts can be used for transportation and other necessary expenses. When the student reaches age 21, the plan becomes managed by the student, meaning those funds could also be used on a summer trip to Bali. Definitely something to consider.
For parents who want to retain ownership of their savings and ensure they only go education costs, there are 529 plans.
A 529 plan is a state-run college savings plan offering tax and growth benefits. An easy way to think of 529 plans is that they are to college savings as Roth IRAs are to retirement.
Early iterations of 529 plans included prepaid tuition plans but those are becoming less popular in favor of investment accounts filled with after-tax contributions to investments such as stocks, bonds, and real estate.
In addition to maintained ownership, these accounts are attractive for parents for their generous income and age limits, high contribution caps, and because the beneficiary can easily be switched if a child decides not to use it.
When it comes time to use your 529 funds, you can withdraw contributions and earnings tax-free for any qualified education expense. For college, those expenses include:
- Tuition and fees
- Books and supplies
- Computers and internet access
- Room and board (if enrolled at least half-time)
- Special needs equipment
If the beneficiary doesn’t use some or any of the 529 plan, you can always change the beneficiary to another qualifying family member, make yourself the beneficiary to further your own education or take up to $10,000 tax-free to use for K-12 tuition.
And, since 529 plans are considered “parent assets” on the Free Application for Federal Student Aid (FAFSA), the value reduces eligibility for need-based aid by at most, 5.64%, versus a student asset like a UTMA or UGMA which reduces it by 20%. That could make a big difference when applying for grants, scholarships, and student aid.
One great option to look into when considering a 529 Plan is CollegeBacker which allows you to open a 529 Plan in just five minutes. It will help you set savings goals, allows other family members and friends to contribute to the plan, and you only have to pay what you can for the service (pretty sweet).
Coverdell Education Savings Account (ESA)
For more flexibility when it comes to picking investments, parents can opt for an ESA. With these accounts you’re fully in control of what investments go into them. Anyone with a modified adjusted gross income of less than $110,000 — $220,000 for joint contributions — can contribute to one.
The major downside of an ESA is the maximum you can save every year for each beneficiary is $2,000, no matter how many accounts are opened in their name. And the entire account must be spent by the beneficiary’s 30th birthday.
Both the 529 and ESA are tax-advantaged in that you don’t pay tax on growth when withdrawing funds for qualifying educational expenses but contributions are “after-tax” meaning you won’t get federal tax benefits on contributions.
The only tax difference is that since 529s are state-run, many contributions qualify as deductions on state tax returns, whereas ESA contributions won’t. This isn’t a big deal in Florida where there’s no personal income tax but this could be a deal breaker for a Georgia resident who can deduct up to $2,000 per year on state taxes for every beneficiary.
Ultimately, don’t let the choices overwhelm you. Using any of these methods to start saving for college will put you ahead of the game even if your circumstances change and you change methods later.
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