Tips to Save for College
How important is it to save for your child’s education? The truth is, not all kids will go to college, nor should they. The career path you choose is yours alone and not a one size fits all solution, but saving can be helpful for other types of training or education as well. Saving for future plans is a good thing to make part of your savings plan.
For this discussion, let’s stick with saving for college.
Did you know that according to educationdata.org only 64% of parents are saving for college? Which means 36% aren’t saving for college at all. For those planning and saving, most expect to pay for about 30% of their child’s college expenses but in reality, they actually only pay about 10%. So does this mean they aren’t saving enough? Maybe.
In 2020-21, the average per year cost of a public 4-year college was $10,740 for in-state tuition and around $38,070 a year for a private college. Americans seek to save right around $55,000 which falls short of the mark. But by the same token, it can be difficult to determine the amount needed for a child’s education. Especially if your child wants to move beyond a 4-year program into some kind of specialty that requires a Masters Degree or Doctorate or more.
The good news is, there are options to save for your child’s education. No matter what way you choose to save, the best decision you can make is to actually do it and start as early as you can. Even if you can’t save much, anything you can manage will lessen the burden of tuition once your child gets to school.
Here are some great options:
1. A 529 plan - This is a tax friendly investment account when its used to pay for qualified education expenses. You can use the 529 for college or k-12 tuition. It can also be used for apprenticeship programs and student loan repayment.
One advantages of this plan is the tax friendly aspect. The 529 is similar to a Roth IRA, by investing your after-tax contributions in mutual funds and similar investments. When you withdraw the money for college it won’t be taxed. Many states will let you deduct your contributions from your state income tax as well.
Another advantage is of the 529 is it has minimal impact on your financial aid eligibility when the account is owned by a dependent student. In that case the distribution doesn’t have to be reported on the FASFA, or federal student aid application, that all students have to fill out.
If for some reason your child ends up not going to college, you can withdraw the money with a penalty on the earnings portion of the balance. There are a few exceptions.
If you have money left in the account, there are few options that involve changing the beneficiary of the account to someone else who is in school. There are other accounts for people with disabilities that the funds can be rolled into as well. Or it can be used for K-12 tuition or for a sibling.
There are a few types of 529 plans, explore your options for this one.
2. Roth IRA - I know what you’re thinking, isn’t that for retirement? Afterall, IRA stands for individual retirement account. And the answer is Yes, but it doesn’t have to be. A Roth IRA is an after-tax investment which is a good thing. One con for the IRA is that other relatives can contribute to a 529 but they can’t to a Roth IRA.
With a Roth IRA you can withdraw the funds once you turn 59 tax-free without a penalty. But if you take them out for college it’s considered an untaxed income to the beneficiary. One big advantage is if your child decides not to attend college, then the parents can use that money for their retirement. This makes it a good option for both retirement and college and a Roth IRA doesn’t require you to withdraw at a certain age so you can continue to save in that account longer.
3. A Coverdell Education Savings Account, known as an ESA, was previously the Education IRA. It’s similar to the 529 plan in that it is tax-deferred and can be used for elementary, secondary and higher education expenses, which can include room and board. Distributions are tax free as long as the funds are used for educational purposes. It does however, count as an asset when filing your FASFA no matter who owns the account.
A Coverdell account allows for a more varied investments while a 529 is more limited in options.
One other thing to consider, these ESAs are geared to low and middle income families. The max adjusted gross income is $190,000 for married couples filing jointly and $110,000 for single filers. You will need to check to see if you qualify for the ESA.
One other caviat to keep in mind, contributions should be made before the beneficiary turns 18 and the funds must be used by the age of 30 to avoid tax penalties. So you have a few things to consider for this one.
4. Eligible savings bonds - You can purchase savings bonds from the US treasury at treasurydirect.gov. These can be redeemed for higher education expenses, and in that instance you don’t have to include them in your gross annual income on your taxes. This does exclude room and board so this would be for tuition.
An advantage of a savings bond is that they will be guaranteed by the government, but the interest rate is usually a really low fixed rate, so you can increase your investment but it may be by a fairly minimal amount. If you do choose one that has a variable rate, you may enjoy some higher rates, but you also may experience some truly low ones.
5. Custodial account - These are savings accounts that are also called UGMAs and UTMAs (Uniform Gift to Minors Act and Uniform Transfers to Minors Act). It’s a brokerage account opened by an adult on behalf of a child. The funds are invested in things like stocks, bonds and mutual funds.
The use of the funds is not limited to education, it can be used on cars, computers or really anything that benefits the minor. There’s also no limit to how much you can invest. People often say that this option is probably best for a child who you know will be responsible with the funds because the account is transferred to the child as early as 18 years old. At that point they decide how to spend it.
Any Earnings and gains on the account can be taxed but it’s to the minor at a lower rate.
Custodial accounts are counted as student assets on the FAFSA, which means they can affect student aid.
A quick note on the difference in the accounts. A UTMA account has greater flexibility in regard to assets. It can hold common types like stocks, mutual funds, etc, but it can also hold assets like real estate, jewelry and collectibles.
UGMA accounts can only hold the most basic forms of investment types like stocks, bonds, and mutual funds.
6. Mutual Funds - Mutual funds are a variety of investments usually managed by a financial advisor. Mutual funds are popular for retirement plans as you can invest your money in several different types of options including stocks and bonds. The thing to remember is your earnings are subject to annual income taxes. The big advantage is you can spend the funds on really anything – like cars, airline tickets, computers, etc.
Mutual funds assets will impact your FASFA application.
7. Home equity loans - This entails using the equity in your home to take out the loan. It’s not the greatest option but if you have equity it is a viable option.
When you are deciding what plan fits your needs the best, there are some questions you might ask yourself.
Do you plan to use the funds only for college expenses? A 529 plan may be a good fit…
Do you prefer to use the funds for other expenses?
If you think you will need the funds for expenses outside of college tuition, or for those kids that don’t choose a traditional college route, you may want a more flexible option.
Also consider the amount you want to contribute and make sure your choice is within those limits.
Don’t forget there may be other ways to get additional money for college.
Apply for Scholarships – that can add up quickly and be a big help
Saving up from jobs throughout school can help.
Dual enrollment can give you college credits while still in high school, this lessens the amount of time you are actually in college which means you won’t have as much to pay as much in tuition.
The best savings path is not one size fits all. Evaluate what’s best for you and your needs. But start early if you can!
A little bonus bit of information. I can’t believe I’m saying this, but there are instances where you should consider not saving for college. Hear me out. In these cases, there are other financial priorities that should come before college savings.
1. You’re In Debt:
Bad debt, not the good debt like a mortgage but excessive credit card or personal debt. That is more likely at a higher interest rate and costing you more than good debt like your mortgage. It’s better to pay that debt down first.
2. You Have No Emergency Fund
The suggestion is a cushion of 3-6 months salary for an emergency fund. That can get you through an unexpected economic loss and really is a priority over college savings.
3. You’re Not Saving For Retirement
Here’s the truth, you can borrow for college, but you can’t borrow for retirement. Preparing for your family’s future really should be the priority.
4. You Have A Short Time Horizon
Some might say it’s never too late to save for college, but that’s not always true. Depending on the age of the beneficiary, your state of residence, and personal financial situation it may not make sense to use a dedicated college savings account or to save at all. If it’s a later start, traditional options like a 529 may simply not be the best course of action. In these cases, I would visit with your financial institution or a financial advisor and get some help working through options. This can include the financial aid department at the school your child has chosen.
5. Remember There are other options
Lastly, it may not make sense to save for college if you have a just straight-up better option. If you are investing in a successful business or some kind of unique real estate or other unique opportunities, it may be more important than college savings. Focus on that growth. Just know That is a risk you have assess for yourself and you decide what is more important.
Again, there are options for paying for school. And they will be different for different people and different circumstances.
There are Grants, scholarships and not a great or fun option, but there are student loans. Military service can be an option to pay tuition. Some employers will help pay tuition as well.
You have to give it thought and really consider all your options. Maybe even get creative and think outside the box.
If any type of continuing education is a goal, then one of the saving options we talked about could be a great way to help reach that goal. The earlier the better, but every dollar you save can help defray costs.
As we’ve said, there are many options and it’s important to find what works for you. Always remember, you can ask for help. Financial advisors or your credit union or bank are a great place to start and as your child reaches the age to start their college journey, utilize the counselors at their school and the financial offices at the college or school they are interested in attending. This is their job and they are a wealth of knowledge, they are ready to help you find the answers you need.