If you’re a parent, you’ve probably heard the mantra that education is the key to a successful future for your child. You’ve probably also heard about the skyrocketing costs of a college education.
Average college tuition and fees at a public four-year university increased by 213% between 1988 and 2018, to an average of $9,970 per year, adjusted for inflation. At private institutions, average tuition also more than doubled over that period, from $15,160 to $34,740 a year.
The escalating costs of college may have you worried about how your child will pay for higher education. You may be concerned that he or she won’t be able to afford the college of their dreams, or that they will end up with a crushing student loan burden, as so many people do today .
Given this reality, you’re smart to think about how to start saving for your child’s tuition, even if your kids are still young. While many parents want to help with college eventually, the truth is that most are not prepared to do so.
One survey found that 70% of parents plan to pay the full cost of college for their kids, but less than 30% are actually on the path to making that a reality. Another study reported that 44% of parents with a child under 18 have not started saving for college.
If you truly want to give your child the gift of a college education and free them from overwhelming student debt, the time to plan is now. Here’s a guide to how to start saving for your child’s tuition today.
When to Start Saving for Your Kids’ College Tuition
It’s never too early or too late to start socking away money for your children’s education. If you can afford it, the earlier you start, the better. Getting a head start gives your money more time to grow over the long term, and rebound after any dips.
It also means you can recalibrate if your child seems to be on track for scholarships related to sports or academic achievements, or if he or she decides to forgo college. Keep in mind that money you save will generally affect the financial aid package your child qualifies for.
Before you launch a college savings plan for your kids, you need to make sure you have your other financial ducks in a row. First, you should focus on paying off any credit card balances or other high-interest debt. You also want to make sure you’ve paid off your own student loans, saved an emergency fund with three to six months of living expenses, and are on track in terms of saving for retirement.
After all, your child always has the option to take out student loans, but you can’t rely on that to pay for a crisis or retirement. You wouldn’t want to have saved for your kids’ college only to burden them with your living expenses after you retire because you haven’t built a nest egg.
The Best Ways to Save for Child’s College
If you’re ready to start saving for your kids’ education, you may be tempted to keep that cash reserve in a savings account. While it might seem like that would protect your funds from market ups and downs, you might actually be losing money.
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That’s because even accounts with the best interest rates aren’t keeping up with the pace of inflation. Especially if your child won’t be going to college for a while, investing your savings is a way to see your money grow. Here are some of the best ways to save for a child’s college:
A 529 plan, also known as a “qualified tuition plan,” allows you to save for education costs while taking advantage of tax benefits (the plan is named after the section of the Internal Revenue Code that governs it).
These plans have been around since 1996, but most Americans don’t use them—or even know they exist . 529 plans break down into two categories: educational savings plans and prepaid tuition plans.
Educational savings plans, which are sponsored by states, allow you to open an investment account for your child, who can use the money for tuition, fees, room and board, and other qualifying higher education expenses at any college or university. You can also use up to $10,000 a year to pay for schooling costs before college.
You can invest the money in a variety of assets, including mutual funds or target-date funds based on when you expect your child to go to college. The specific tax benefit depends on your state and plan. Generally, you contribute after-tax money, your earnings grow tax-free, and you can withdraw the money for qualified expenses without paying taxes or penalties. If you withdraw money for anything else, you’ll pay a 10% tax penalty on earnings.
Prepaid tuition plans, as you may expect, allow you to prepay tuition and fees at a college at current prices. These plans are only available at certain universities, usually public institutions, and often require you to live in the same state. A prepaid tuition plan can save you a lot of money, given how much college costs are increasing each year.
Depending on the state and the 529 plan, you may be able to deduct contributions from state income tax. However, note that if your prepaid tuition plan isn’t guaranteed by the state, you might lose money if the institution runs into financial trouble. You also run the risk that your child will choose to go to a school that’s outside of the area covered by the plan.
Traditional or Roth IRA
Traditional and Roth IRAs are mainly vehicles to save and invest for retirement, but both can be used as a college savings tool as well. With a Roth IRA, you save after-tax dollars, but do not pay taxes on the money when you withdraw it. If you’re over age 59½, you can withdraw money to fund college (or for any other reason).
If you’re under 59½, you can still take out earnings to pay for qualified higher education expenses, such as tuition, fees, and supplies, without paying the 10% penalty that would normally apply, if you’ve had and contributed to the account for at least five years. The expenses can be for yourself, a spouse, a child, or a grandchild.
With a traditional IRA, you contribute pre-tax dollars, but you pay taxes on the money when you take distributions. You can’t take out your contributions until you hit age 59½ without paying a 10% penalty. Like with a Roth IRA, you can use the funds for qualified higher education expenses without incurring that penalty (though you’ll still have to pay income tax on the money you take out).
When using an IRA to save for college, remember that saving for retirement is a priority. Also, keep in mind that you might not be able to save as much as with a 529 plan. For 2019 , you can only contribute $6,000, or $7,000 if you’re 50 or older, to an IRA.
Coverdell Education Savings Account
Like a 529 educational savings plan, a Coverdell ESA allows you to set up a savings account for someone under age 18 to pay for qualified education expenses. The money can be invested in a variety of stocks, bonds, or other assets, and grows tax-free.
Unlike with a 529 plan, your contributions are not tax-deductible, and the plan is only available to people who make less than a certain income limit (modified adjusted gross income of $110,000 for an individual, or $220,000 for a married couple filing jointly).
When your child withdraws the funds for educational expenses, they won’t pay taxes on it. The money can also pay for elementary or secondary education. But note that you can only contribute $2,000 per year to a Coverdell ESA per beneficiary.
UGMA and UTMA Accounts
You can open a Uniform Gifts to Minors Act or Uniform Transfers to Minors Act account on behalf of a beneficiary under 18, and all the assets in it will transfer to the minor when he or she becomes an adult (at age 18 or 21, depending on the state). Your child will be able to use the funds for anything they want.
That means they won’t be limited to qualified education expenses, but can also pay for other living costs or discretionary purchases. Another plus is that you can contribute as much as you want. The downside is that there are no guaranteed tax benefits, and you can’t control how your child will spend the money when the time comes.
Another good way to invest money for your child’s college education is with a SoFi Invest Account. You can contribute as much as you want every year, and the funds can be used for any expense, meaning they can pay for college or be put to a different use if your needs change.
Your money will be invested in a diversified portfolio of Exchange-Traded Funds (ETFs), actively managed by advisors and geared toward your risk tolerance. This mix of automated investing and human expertise offers a low-cost way to get into the market, while diversification and monthly portfolio rebalancing can help keep you comfortable with the level of risk.
Given the increasing cost of college, you’d be smart to start saving for your children’s education today. But don’t lose out by keeping the money in a simple savings account. Instead, choose an option that lets you grow your money and make your kids’ dreams a reality.
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