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.
In-state tuition and fees at public universities have increased 212% in 20 years, U.S. News reported. Out-of-state tuition and fees at public schools have risen 165%. And private colleges have seen a 144% increase.
The escalating costs of college may have you worried about how to pay for higher education. You’re smart to think about how to start saving for college, even if your kids are still young.
A recent Fidelity survey found that parents plan to cover an average of 65% of the total cost of college. But it also noted that parents are on track to meet just 33% of their college savings goal.
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.
When to Start Saving for Your Kids’ College Tuition
Here are the 2020-2021 annual total cost of attendance numbers, on average, from the College Board, based on a modest budget:
• Four-year public college, in-state student: $26,820
• Four-year public college, out-of-state student: $43,280
• Private college: $54,880
With those numbers in mind, it’s never too early to start socking away money for your children’s education. Getting a head start gives your money more time to grow over the long term and to 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 your child decides to forgo college. Keep in mind that the money you save will generally affect the financial aid package your child qualifies for.
Before you launch a college savings plan for your kids, it’s best to have your other financial ducks in a row. You might first focus on paying off any credit card balances or other high-interest debt with a debt consolidation loan. Then you might want to make sure you’ve paid off your own student loans and saved an emergency fund (generally three to six months’ worth 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 higher 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.
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 you might see your money grow. Keep in mind that investments can lose money.
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 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.
Not all states offer tax benefits, so be sure to look into this when choosing your plan.
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, 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 the area covered by the plan.
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.
Your contributions are not tax-deductible, and the plan is only available to people who make less than a certain income (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 qualified 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 to 25, depending on the state).
Young adults are able to use the funds for anything they want. That means they won’t be limited to qualified education expenses. Another plus is that you can contribute as much as you want. The downside is that there are no tax benefits when contributions are made. Earnings are taxable.
A custodial account is an irrevocable gift to the minor named as the beneficiary, who receives legal control of the account at the age of majority.
Given the increasing costs of higher education, parents are smart to save for a child’s college early and often. But rather than keep the money in a savings account, they’d likely benefit by choosing an option that lets their money grow.
Parents trying to build up their own money might consider Sofi Invest. With a SoFi Invest account, you can contribute as much as you want every year, and the taxable earnings can be used for any expense.
Trade stocks, exchange-traded funds, and crypto or start automated investing.
And as a SoFi member, you’ll get complimentary access to Edmit Plus, a tool to estimate financial aid, compare cost of attendance, and learn about available scholarships.
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