How To Start Saving For College: The Essential Guide
Kevin Graham6-minute read
December 16, 2020
Going to college is now necessary to compete for many of the jobs available in today’s economy. However, the cost of college continues to rise. According to U.S. News, the average per year cost is as high as $35,087 at a private university in the 2020 – 2021 school year. If you’re attending an in-state public institution, the cost averages $9,687 while out-of-state residents pay $21,184.
Given those numbers, saving for college might seem like an impossible challenge, but if you start early, it need not be an insurmountable hill to climb.
When Should You Start A College Fund For Kids?
While saving money for your child’s education is an admirable goal, don’t neglect your own finances. It might not be ideal that you or your child needs to take out loans to pay for college, but there can be alternatives, like applying for grants and scholarships. Besides, if you don’t take care of your own finances first, how can you expect to take care of someone else’s?
Before figuring out the best way to save for college, you should take a few steps to tend to your money first. This includes making paying off your high-interest debt a priority, setting up an emergency fund to cover unexpected expenses and stashing money away toward retirement funds.
Once you’ve got a good handle on that, it’s time to think about your child’s college funds. The earlier you start, the better. Of course, it’s not always possible, but every little bit helps. Consider automating your savings as well – think designating a specific amount from your paycheck each month to an account of your choice.
How Much Do You Need To Save For College?
When figuring out how to save for your kid's college fund, think about how much you want to set aside to help. Do you want to fund half or a small percentage of tuition? Getting clear in your commitment now can help you determine an amount to aim for.
Some experts say it’s a good idea to save around a third of the total cost of college, but everyone’s situation and savings goals are different.
There are calculators that help estimate how much it’ll cost by the time your child’s ready to enroll – the college cost calculator from The College Board is one such example. From there, you can see what approximate costs are and work out much you’ll need to set aside in savings to reach your goal.
Because personal circumstances vary, you should consider speaking with a financial advisor to determine the right saving strategy for you and your family.
What Are The Best College Savings Plans?
There is no shortage of college saving accounts for your child. Each option has its pros and cons based on your individual situation. In other words, there isn’t one best all-around account.
Here are some of the more popular options for parents to choose from:
Yes, it is a retirement savings account, but this tax-advantaged vehicle can be used for college savings. You contribute post-tax dollars and you can withdraw any investment gains penalty-free after 5 years to pay for eligible educational expenses. For the 2020 and 2021 tax years, you can contribute a maximum of $6,000 per year (plus an extra $1,000 if you’re older than 50) and there are income limits.
It’s worth noting that your maximum contribution to a Roth IRA may be reduced depending on your income and tax filing status. Check IRS rules for more detail.
Here are some pros and cons to consider.
- Withdraw contributions tax-free at any time.
- Investment earnings can be withdrawn tax-free after a 5-year waiting period from the time you set up your first Roth IRA, regardless of age.
- If taxes go up between the time you contribute the funds and withdraw them, the Roth has proved advantageous for you.
- You’re taking away from your retirement funds to pay for college.
- You can’t take a tax deduction for Roth contributions.
- If taxes go down after you made your contribution, you don’t get the benefit of the lower tax rate that you would’ve had if taxes were paid when you withdrew the funds.
529 College Plans
Also known as a Qualified Tuition Program, 529 plans allow you to put after-tax money into an account and withdraw funds to use for qualified educational expenses tax-free. There can be different requirements, maximum contributions, investment options and fees for your state (if it offers one), so check the fine print.
Let’s run through pros and cons.
- Contributions are possibly tax-deductible or there may be credits you can take depending on your state.
- Withdrawals on contributions and earnings for qualified education expenses are tax-free.
- You control the account instead of the beneficiary.
- If your child doesn’t end up attending an institution of higher learning and the money is used for other purposes, there may be taxes and penalties.
- The rules and benefits are different in every state. Be sure to check local plans and speak with a financial advisor.
Coverdell Education Savings Account
This account is similar to a 529 college plan in that your funds generally receive tax-advantaged benefits if you use it for qualified educational expenses. The main difference is that you can use it to cover K-12 expenses, not just costs associated with college.
Here’s a list of pros and cons.
- Distributions can be used for qualified elementary, secondary and higher education expenses.
- You control the account instead of the beneficiary.
- Contributions aren’t tax-deductible and they have to be paid in cash.
- Distributions not used for qualified education expenses may be subject to taxes and penalties.
Prepaid College Tuition Plans
You can use these accounts to pay for part of your child’s college tuition now. That way you can pay current prices and avoid expensive tuition hikes. Not all states offer these plans, so check to see what’s available.
Here are the major pros and cons of this option.
- Since the cost of tuition only ever seems to go up, you’ll likely be prepaying at lower rates.
- Prepaid tuition programs follow the same general guidelines as 529s, so there may be available tax deductions and credits depending on your state.
- Although we talked about college here, these programs can also be used for elementary and secondary education.
- To the extent that this option is offered in your state, the ability to pay for prepaid credits may be limited to participating state universities. This can be limiting in terms of college choices.
- If money isn’t completely used for qualified educational expenses, it may be taxable and/or subject to penalties.
How Can Students Help Save For College?
While it’s great if Mom and Dad can cover or even pitch in for college expenses, it’s not realistic to expect parents to be able to pay for everything. It’s also not a bad idea for a young person to feel like they have something at stake here. They can help pay for college as well.
If your child wants to go to college as part of preparing for a future career, it’s important to sit down with them early and have a talk about finances. When they’re old enough, set up a savings account.
Show them a breakdown for the performance of any investment vehicles you might have their college fund in. In this way, they get a feel for looking at monetary growth over time and how investments work. You could even introduce the concept of risk vs. return. If a child understands how investments work, it may deepen their appreciation for money.
They’re also less likely to frivolously spend money if they know how hard it is to get. Having a part-time or seasonal job can accomplish two things: Not only are they able to save for the cost of college, they can also learn the value of an honest day’s work. If they have to scrape for every dollar, they’re more cognizant of how they’re spending it.
The Bottom Line On Saving For College
When it comes to saving for college, it doesn't hurt to start as soon as possible. While it will depend on your personal circumstances, experts recommend planning to save for at least a third of college costs.
There are several ways to pay for college expenses, including Roth IRAs, 529 plans, the Coverdell Education Savings Account and prepaid tuition plans. Each has its benefits and disadvantages. If you’re unsure which is right for you, speak with a financial advisor. Finally, don’t hesitate to have your child help pay. This will help them be invested in their education.
We hope this has illuminated some college savings options. For even more tips, check out our section on personal finances.
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