Between the many activities that keep parents busy, saving for your children's college education stays on your mind. Just as they quickly grow out of their cute little onesies, you will soon move them into their first college dorm room.
In the meantime, there's a lot you can do over the years to build a college savings account.
Why it's important to save for college
There are two reasons why learning how to save for your kids' college is extremely important:
- Higher education becomes even more important in stiff competition for employment.
- Student loan debt can set your children up for financial failure.
Despite the "historically low" unemployment rate, many graduates enter the workforce underemployed, overworked and underpaid. Qualifications for jobs in their fields may be higher than the compensation package employers are offering. That may leave younger generations working jobs that do not justify the cost of their education.
This is not to mention the watered-down status of many graduate-level degrees. The piece of paper students worked so hard for doesn't always hold its weight in the job market. When that happens, many find themselves back in school to get another degree or certification for a better career. Without funds set aside, that means more debt.
What about scholarships and grants?
Scholarships or even financial aid awards are not guaranteed. When those student resources are not there, and parents have not prepared, it leaves families resorting to student loans. With student loan debt on the rise, it is highly important to start preparing for college now.
Student loans are not the only form of borrowing that may leave you in the red after college. At least 30 percent of students (or their parents) rack up revolving debt like credit cards and home equity lines of credit. Knowing what to expect beforehand can save your pocketbook from a mountain of debt.
How much should I save for my kids' college education?
To have a clear idea of how much to save for your kid's college, make a list of higher education expenses. Keep inflation in mind, knowing you won't start making these payments until almost 20 years from now.
Tuition and fees. his can vary widely depending on the type of school and the location. Starting at a junior college is less expensive than a four-year college or university. Private institutions may also have a higher price tag than state-funded schools. There are also out-of-state fees that can pack on nearly half the amount of tuition alone.
If you expect to send your kids to one of the best national U.S. schools, the costs range between $10,000 and $60,000 per year. The average current cost for an undergrad student to attend a four-year, public out-of-state college is $36,420 annually. In-state is $20,770 per year. A public two-year in-state school will run you $11,970 per year. That includes room and board. A private non-profit four-year school is the most expensive at $46,950 annually.
Books and Supplies. Expect to spend between $1,300 and $1,500 on books and supplies each year.
If a job is not in the plans for your college student, they will need money for clothing, gas and other variable expenses.
Off-campus rent. Rent can vary based on the number of roommates and the geographic area. The national average for the cost of rent is $951 for a one-bedroom apartment, $1,180 for a two-bedroom apartment and $1,500 for a three-bedroom.
Transportation. Getting back and forth to class and around the city will run your student between $1,000 and $1,800 a year.
Miscellaneous. Anything extra depends on your kid's taste and your allowance. Data suggests the average parent stuck to a budget between $1,500 and $2,500 for the year.
Total expense budget. These costs add up to a college expense budget that is between $17,000 and $51,000.
Options to save for college: Savings plans, investments and cash value
Each option you have for saving extra money has its pros and cons for your education goals.
- A regular savings account will not have a high interest rate, so your dollars will not work as hard to earn extra money.
- Mutual funds or other investments will depend on market performance. The money you gain from those investments will vary throughout the years. You could also have taxes on these funds when it's time to pay for college.
- Another option is a cash value life insurance policy. You may also recognize this by the name whole life insurance. As you make payments for the life insurance (premium payments), a portion of the funds builds up similar to how a savings account works, which is your cash value.
- You can borrow from your cash value, but you technically never have to repay the money. Either you gradually replace it with future premium payments over time, or the company reduces the policy's face value before awarding it to the beneficiary. Your access to these funds is tax-free.
Meanwhile, some people feel the best way to save for your child's college is with a 529 plan.
What is a 529 college savings plan?
A 529 plan is an investment that has tax benefits for the contributor and the student. The funds can grow tax-free and are classified as a gift at withdrawal. Students can use the money on qualified education expenses that include up to $10,000 in private school tuition for elementary or high school. There is a large list of colleges who accept 529 funds.
Maximum contributions change, depending on the tax laws. For 2018, the IRS allows gift contributions up to $15,000. Depending on your state, some or all of your contributions may be tax-deductible. You can participate in any state's 529 plan, and your kids do not have to attend college in that state.
There are two main types of 529 plans and several that fall in a category under each type. You have your choice of a college savings plan or a pre-paid tuition plan. The college savings plans function like a Roth 401(k) or IRA with by investing after-tax money into stocks like mutual funds.
With a pre-paid tuition plan, you can pay all or a portion of your child's in-state public college expenses. Alternatively, you can pre-pay the cost of education for a private college through the Private College 529 Plan. The colleges themselves offer the pre-paid tuition plans.
Benefits of 529 plans
529 plans have more flexible rules than most other investments. The contributor controls the account, so you can make sure your children use the funds for college. You do not have to report contributions on your tax return, and there are no income or age limits for those who want to take advantage of the savings plan.
When you purchase life insurance, you may learn about the incentives for starting a 529 plan. Some businesses even offer to contribute a small sum to the account as a cash back reward when you link a debit card and spend at their stores.
Drawbacks of a 529 plan
The IRS controls what qualifies as a necessary expense. That means to benefit from the tax-free advantage, you must use the funds as their rules state. Eligible expenses currently include:
- Tuition and fees
- Books and supplies
- Room and Board (if enrolled at least half-time)
Some things you may expect to qualify do not, such as transportation. If you spend 529 funds outside of a qualified expense, you must pay taxes on the portion you earned from investments plus a 10 percent penalty at when you file your income taxes. Expect the same consequences if you withdraw the money because your child opts not to attend school.
Some exceptions to these penalties for not using the money on qualified expenses is if your child becomes disabled or passes away, goes to a U.S. military academy, or gets a tax-free scholarship. You can also avoid taxes and penalties by transferring the funds to another family member or yourself for college. Another option is to use an IRA account.
Using an IRA to save for college
The pros and cons of an IRA and 529 are different, so a tax-deferred IRA may work better for many. With this account, the contributions and investment activity is similar. Since it is technically an account for retirement, IRS rules require delaying withdrawal until 59 ½.
However, one of the few exceptions to this rule is paying for college.
Where's the money? How to save for your kid's college fund
Now that you have an idea of how much money you need to save and where to put your savings, you need to decide where the funds will come from. It's time to evaluate your income, expenses and what you can afford to set aside for your children's future.
If you do not have it in the budget today, look at where you can start paying off debt. As you free up money, save it using one of the options above, such as the 529 plan.
Let GuidedChoice help you save and invest
It seems like a lifetime away, but the years will roll by quickly. The sooner you get started, the better it will be for you and your little ones. If you choose to explore options other than a 529 savings plan, like an IRA, check out our IRA – it comes with professional investment advice and management, making it an easier and smarter way to invest. We have the tools to help you start investing in your children’s future today.