College is expensive: $ 35,720 per student, according to data from educationdata.org.
Many personal finance experts follow the airplane oxygen mask rule: make sure your own finances are in order before saving for your children. Before you save anything for your child’s future college expenses, make sure it doesn’t affect your own savings, retirement savings, and ability to pay off high-interest debt.
However, if you are able to save for your child’s future tuition fees, there are things you can do now to help your child afford the high cost of college later. And the best way to save for college is to choose a savings plan that works for your financial situation and goals.
Where to start
- This is how you save for college
- Best college savings plans
- Roth IRA
- Education Savings Account (ESA)
- Taxed brokerage investment account
- Estate planning
- Diversify college savings
This is how you save for college
1. Start early
It really is never too soon to start saving up for your child’s college education.
Just like with investing, saving early and often will give you the best results over time. “Start the moment you decide to become a parent,” said Leyder Murillo, executive director and financial advisor at Wolfpack Investment Management in Los Angeles. “The time horizon is your friend here, because the investment should increase as the child gets older.”
2. Set a savings goal
Decide how much you want to contribute to your child’s education. If your goal is to cover 100% of your child’s study costs, you need to save differently than if you only want to pay part of the study costs.
“You may find it appropriate to commit 50% and leave the rest to your children through part-time work, scholarships and grants, or student loans,” said Eric Roberge, a CFP and founder of Beyond Your Hammock. a wealth management company based in Boston. “This is an individual decision that is left to you and your family and there are no wrong answers here.”
The cost of tuition is getting more complex, so figuring out how much the tuition will cost your child can be challenging – even more so if you are planning how much college will cost in 10-15 years. Scholarships, state grants, and the college your child goes to all affect the final bill. The current average cost – $ 35,720 per student – provides at least a guide to determining how much you want to save.
3. Choose a savings plan
There are a variety of savings plans to choose from, and it’s important to understand the implications of each one and what they can mean for your child’s future.
As you think about how much you can add to the plan you choose, review your cash flow to determine “how much you can realistically put towards saving college without disrupting your current lifestyle or saving for other goals Says AnnaMarie Mock, wealth advisor at HIGHLAND Financial Advisor in Wayne, New Jersey.
4. Ask for help
Especially if you started early, don’t be afraid to ask friends and family to contribute to your child’s savings plan instead of gifts.
“Instead of asking for toys or material items for a baby shower, birthday, Christmas, baptism, quinceanera, or other celebration, let them contribute to a college fund,” says Murillo.
Murillo recommends writing instructions directly on the invitation: “In lieu of gifts, consider contributing to (Name) s college fund. Instructions on how to contribute are listed below. ”Then add the custodian information and any forms that the donor will need to fill out.
Some custodians even offer templates for this scenario that you can mail out, or ways for people to give gifts through an online portal.
Best college savings plans
There are many ways you can save your child’s tuition fees. Some plans have restrictions and penalties when used for non-college expenses, while others offer a little more flexibility. As with retirement planning, there are benefits to having a diverse approach to saving in college.
Here’s a closer look at some of these most common options:
529 savings plan
One of the most famous college savings plans is 529 accounts. These tax-exempt plans are offered in almost every state, although there are slight differences in how they work depending on where you live.
Income within 529 is tax-deductible and payouts for skilled education expenses are tax-free, says Ryan Mohr, a CFP and founder of Clarity Capital Management in Portland, Oregon.
529 plans vary by state. Some states offer a tax credit for contributions to the plan; others offer tax deductions. If your state contributes a 529 tax-deductible fee, “it usually results in optimal savings,” says Leo Marte, CFP at Abundant Advisors in Huntersville, North Carolina.
And even if your state’s plan doesn’t offer additional tax incentives for annual filing, you can still look for other state-sponsored plans that may offer better portfolio options or lower costs.
Another type of 529 is a prepaid 529 or prepaid study plan, which allows you to purchase study credits at today’s cost, with a guarantee of future use – regardless of the cost back then, says Marte.
Currently, only 18 states support prepaid curricula, and some require residency in that state. These plans are often designed for an approved list of institutions. While you usually transfer the credit or get a refund, there may be a contractual penalty.
Prepaid plans can also limit the use of the credit. While funds from a 529 savings plan can be used for any qualified college expenses (think tuition, materials, computers, room and board), a prepaid plan usually only covers tuition.
A Roth IRA is an investment account that allows you to deposit up to $ 6,000 per year as long as you do not exceed certain income limits depending on your enrollment status. Roth IRAs offer more flexibility in withdrawing funds, making them ideal for more flexible savings goals.
If your child isn’t going to college or getting a scholarship and you don’t need the money saved, you can leave that money in your Roth and use it for retirement or even renovations / repairs. However, if you need to complete it for higher education spending, the IRS’s 10% early repayment penalty is avoided.
Instead of investing every dollar in a 529, diversify your college savings strategy.
“If 2020 has shown us anything, the ability to remain flexible and adapt to a changing world is a huge asset,” said Wakefield Hare, financial planner at Greater Than Financial in Kansas City. “The Roth IRA enables parents to do this for their children and do what is best for them.”
One downside to choosing a Roth over a 529 is the waiver of the state income tax deduction that many states offer with a 529 Roth IRA as the primary way to save for retirement.
Education Savings Account (ESA)
An education savings account works similarly to a Roth IRA and was formerly known as an education IRA before it was renamed in 2002. ESAs have strict eligibility requirements that make them less useful to some people. You will get most investment options if you make less than $ 110.00 per year as a single applicant, or $ 220,000 if you file together.
You cannot fund ESAs if the beneficiary is 18 years old and the contribution limit is $ 2,000 per year. If your child doesn’t use the funds for college, the ESA will be distributed to them and not back to you.
But the funds in your ESA will grow tax-free, and withdrawals should also be tax-free if you meet certain criteria.
Taxable investment account
A taxable investment account or brokerage account is like a 401 (k) minus the tax break. You can buy mutual funds, index funds, stocks, bonds, and other assets, but you have to pay taxes on things like dividends and capital gains.
“Saving in a taxable account is also a really great savings method because it gives you flexibility,” says Mohr. “And you can use it the way you need to, regardless of what happens to the college landscape for your child.”
If you would like to leave an educational gift for grandchildren or relatives with your estate, you can pay part or all of the tuition fees directly to a university – without being subject to gift tax rules. This also reduces your taxable estate, says Marte.
Diversify college savings
While a 529 savings plan is one of the most popular ways to save for college, there is a reason how you save for your child’s college. “I don’t usually advise putting every last dollar you have into a 529 plan,” says Roberge.
This is because your child may not choose college at all and you may face penalties for attempting to withdraw this money for purposes other than college expenses.
To protect yourself from this possibility, Roberge recommends taking your college savings goal, maybe $ 500 a month, and $ 250 on the 529, the other $ 250 on some other form of savings account with more Flexibility, like depositing a taxable brokerage investment account.
“The money in the placement can be used for any purpose at any time, so that parents have some flexibility if things don’t go exactly as they imagine it would with regard to the children’s studies,” says Roberge.
This strategy also protects against saving too much on your child’s education if they end up attending a cheaper school than expected.