How to save for your child's college education
Military parents understand the importance of saving for their child's college education. However, with tuition rising steadily, you may not realize just how much you'll need to pay for college in the future. To stay ahead of increasing costs, it's more important than ever to begin saving early and to have smart saving strategies.
Here's something to think about. Public university tuition increased by an average of 8 percent in 2011, and private universities have historically increased tuitions an average of about 6 percent per year. More recently, public and private institutions hiked tuition by 2.9 to 3 percent in 2013-14, the smallest increase in more than 30 years.
For perspective, let's say you want your newborn to attend a four-year college that costs $10,000 per year today. You can hope tuition increases stay low, but if that college's costs increase an average of 7.5 percent per year, you'll need $147,032 by the time your child is 18 to pay for all four years.
Now, take a deep breath.
If you think saving $147,032 seems impossible, you're not alone. Many parents feel the same way and aim to save only half that amount, while expecting the rest of the dough to come from loans, scholarships, work/study, student earnings and family income.
So, where do you begin and how much do you need to save? Glad you asked.
Even if your child is still crawling around in diapers, it helps to get a rough estimate of how much money you'll need to put away as they get older. You can determine the dollars and "sense" by reviewing the average tuition costs published by organizations like the U.S. Department of Education College Affordability and Transparency Center, which provide several lists of institutions and their respective tuition, fees and net prices. Once you reach a ballpark figure, just apply the national average rate of increase and you'll have a good estimate of what college is likely to cost when it's time for your child to attend.
Ways to save and invest
To develop an effective saving strategy, it's important to have a goal that allows you to watch your progress. In fact, the key to any successful savings plan is compounding interest, which allows you to put away small amounts of money that will work for you by earning interest over time.
You can set up a college fund through any number of investment options offered by banks and investment companies; however, tax-advantaged tuition savings programs authorized by Congress and individual states may make saving a little easier. Here are some options to consider:
• Coverdell Education Savings Accounts - Formerly known as the Education IRA, the Coverdell ESA currently lets individuals save up to $2,000 per year per child for education expenses. Anyone - grandparents, aunts, or cousins - can contribute to the savings plans as long as their income doesn't restrict investments. Coverdell ESA funds can be withdrawn tax-free for education purposes. You don't have to pay taxes on your investment earnings either. However, if you withdraw funds beyond what you're allowed to use for education expenses, you may pay a tax penalty. Coverdell ESAs are not the quickest way to save money, but if you faithfully contribute the maximum amount each year starting when your child is very young, you will end up with substantial savings. If you decide to open a Coverdell account, remember that you may not be able to participate in other savings plans at the same time. Also, you are not permitted to roll over 401(k) or Roth IRA accounts into a Coverdell ESA. Banks and investment companies can give you more information about opening an ESA.
• Qualified Tuition Programs (529 Plans) - These state-run plans named after Section 529 of the Internal Revenue Code have become very popular in recent years. Not every state offers a qualified tuition program, but more and more are beginning to roll them out. The two types of qualified tuition programs are "prepaid tuition plans" and "college savings programs," but both are referred to as Section 529 plans.
• Prepaid tuition plans allow parents to lock in at today's tuition rates and are an excellent idea for families who are fairly certain their child will attend a state school. It's important to remember, however, that participation in a prepaid plan is not a guarantee of admission. Your child will still have to be accepted at the school where he or she applies. Prepaid tuition plans are simple, low-risk plans allowing contributors to pay for an education at a fixed rate. Contributions to these plans are usually subject to federal taxes when redeemed, but the taxes are imposed at the student's rate, not the parents' rate. Some state taxes may be entirely waived when the plan is redeemed. Investments can be made through one-time lump sum purchases or monthly installments. If your child ends up going to a private college or an out-of-state college, some states will refund your payment without interest; others will transfer funds to other state plans and, in some cases, private schools.
• College savings programs are state-sponsored investment programs designed to help families save for college with the help of generous tax benefits and fewer restrictions than other plans. Contributions to these programs generally grow entirely tax-free, and about half the states offer tax deductions for contributions. These savings accounts can be used to pay for education expenses, including tuition, room and board, and books at any accredited university or college in the country. Also, it's usually easy to change the account's beneficiary. Each state has a different Section 529 savings program, and many of them are open to people from other states. Fees, tax benefits and restrictions also vary, so it's important to shop around for the best plan for your needs. Talk to a financial planner who is familiar with Section 529 plans to get additional assistance.
Understanding savings and financial aid
College savings can affect financial aid awards, particularly private grant awards. However, financial aid offers include fewer grants these days and rely more heavily on loans.
Because grants are less common, you can't count on their availability. By saving for college instead of counting on financial aid, you could be disqualifying yourself from some grant aid, but you are almost certainly ensuring that you and your child will have to borrow less money.
Once you decide how you'll save for college, the key is sticking with the plan. Every little bit that you can invest in your savings will help you in the future by earning more interest. Here are some ideas for making saving easier:
• Use automatic withdrawal. An automatic withdrawal plan from a bank account or paycheck places money in a designated account. Keep in mind that if you borrow against a retirement savings plan such as a 401(k), 403(b) or Roth IRA, be sure you can pay it back and afford the interest income you will lose.
• Make contributions to your savings a regular part of paying bills. When you sit down to pay the bills, write the first check to your investment fund, rather than waiting to see if any money is left over after you've paid everything else.
• Allow your strategy to change over time. Investment strategies should evolve and change over time. If possible, you should try to contribute to funds that are more aggressive in the early years. As your child approaches college age (and bill-paying time), choose more conservative investments.
• Start now. Whether your child is an infant, a preteen or even a teen, the best time to begin saving for a college education is now. Once you begin saving, you'll be surprised how quickly your money adds up over the years.