Most parents dream of paying to send their children to college, but these days, that’s no small feat. The average cost of a public, four-year university is $25,700 a year.
If your child attends a private, four-year university, these costs rise to $54,500 a year. And college costs continue to increase every year, so the odds are it will be even pricier by the time your children reach college age.
So just like you wouldn’t put off planning for retirement, you shouldn’t put off planning how you’ll pay for college either. Fortunately, with a bit of planning and lots of savings, it’s entirely possible to fund your child’s higher education expenses.
Key Takeaways
- Start saving for your child’s college education as early as possible, ideally from birth, and create a plan to regularly contribute to a dedicated college fund.
- Consider various college savings options such as Roth IRAs, 529 plans, Coverdell Education Savings Accounts, and prepaid tuition plans, each offering different tax advantages and flexibility.
- Explore ways to reduce college costs, including community college for the first two years, applying for scholarships and grants, filling out the FAFSA, and encouraging your child to graduate in less than four years.
4 Steps to Start Saving for Your Child’s College
If you haven’t yet started saving for college, the process can feel overwhelming. It’s hard to imagine how you’ll save such a large sum of money in a relatively short period of time. If your children are in high school, you’re probably feeling the pressure even more. Here are four easy steps to help you get started and limit the amount of student loan debt your child might need to take on:
Step 1: Start as Soon as Possible
When it comes to saving for your child’s college education, the earlier you start, the better. One of the most significant benefits of starting early is the power of compound interest. This means that the interest you earn on your savings will itself earn interest over time, leading to exponential growth in your savings.
For instance, if you begin saving $100 per month when your child is born, and your investments earn an average annual return of 6%, you would have approximately $38,000 by the time your child turns 18. In contrast, if you start saving the same amount when your child is 10, you would accumulate around $11,000 by the time they reach college age. This example highlights how even small monthly contributions can grow significantly over time, thanks to compound interest.
Example Scenario
Consider a hypothetical scenario where you save $100 per month in a college savings account with an annual interest rate of 6%.
- Year 1: You save $1,200. With compound interest, this grows slightly more.
- Year 5: Your savings total $6,000 in contributions. With interest, you have approximately $6,975.
- Year 10: You have contributed $12,000. With interest, your savings now total around $16,470.
- Year 18: You have contributed $21,600. With compound interest, your account balance reaches approximately $38,000.
Starting early allows your savings to grow substantially over the years, making it much easier to meet the high costs of college education. Even if you can only set aside a small amount each month, the power of compound interest can help you build a significant college fund for your child.
Step 2: Come Up with a Plan
Planning for your child’s college fund involves understanding the various costs associated with attending college. Here’s a detailed breakdown of typical college expenses:
- Tuition: This is the most significant expense. The cost varies widely depending on whether your child attends a public or private university. Public universities average around $25,700 per year, while private universities can cost approximately $54,500 per year.
- Books and supplies: Expect to spend around $1,200 to $1,500 annually on textbooks, course materials, and other supplies.
- Housing: On-campus housing and meal plans can range from $10,000 to $12,000 per year. Off-campus housing costs can vary significantly based on location.
- Miscellaneous fees: These include costs for transportation, personal expenses, and other fees, which can add up to $2,000 to $3,000 per year.
Recommended Tools
To get a more accurate estimate of future college costs, consider using the following tools and calculators:
- College Cost Calculators: Websites like the College Board’s “Net Price Calculator” can help you estimate the total cost of your child’s education based on current rates and projected inflation.
- Savings Calculators: Tools like the “529 Plan Savings Calculator” on Savingforcollege.com can help you determine how much you need to save each month to reach your goal.
- Financial Aid Estimators: Use tools like the “FAFSA4caster” to estimate potential financial aid eligibility, which can significantly reduce the amount you need to save.
By understanding the full scope of college expenses and using these tools, you can create a realistic and achievable savings plan tailored to your financial situation.
Step 3: Pick the Right College Savings Plan
The best way to save for college is by picking the right investment plan. A sound investment strategy allows you to take advantage of compound interest and maximize your returns.
| Savings Plan | Pros | Cons |
|---|---|---|
| Roth IRA | Tax-free growth, tax-free withdrawals for qualified expenses, flexible for retirement | Income limits for eligibility, annual contribution limits |
| 529 College Savings Plan | Tax-free growth, tax-free withdrawals for educational expenses, state tax deductions | Limited to education-related expenses, potential penalties for non-education withdrawals |
| Coverdell ESA | Tax-free growth, can be used for K-12 and college expenses | Income limits for eligibility, annual contribution limit of $2,000 |
| Taxable Investment Account | Flexible use of funds, no contribution limits | Earnings are subject to taxes |
| Prepaid Tuition Plan | Locks in current tuition rates, hedge against inflation | Limited to participating institutions, restrictions on use |
Tax Benefits
- Roth IRA: Contributions are made with after-tax dollars, and earnings accumulate without being taxed. Withdrawals for qualified education expenses are also tax-free if certain conditions are met.
- 529 Plan: Contributions increase without incurring taxes, and withdrawals for qualified education expenses are tax-free. Many states offer state tax deductions or credits for contributions.
- Coverdell ESA: Contributions grow tax-free, and withdrawals for qualified education expenses, including K-12, are tax-free. However, contributions are not tax-deductible.
Step 4: Begin Saving Consistently
To ensure you are consistently contributing to your college savings, consider the following:
Automatic Contributions
Setting up automatic transfers from your checking account to your college savings account can help you save regularly without having to think about it. This ensures that you consistently contribute to your savings plan and take advantage of compound interest.
Adjust Contributions
Review your savings strategy periodically and adjust your contributions based on your financial situation. Consistent saving is crucial for building a substantial fund to save for college and reducing reliance on student loans. If you receive a raise, bonus, or have a change in expenses, consider increasing your monthly contributions. This flexibility helps you stay on track to meet your college savings goals.
By comparing different savings plans and understanding their tax benefits, as well as consistently contributing to your savings, you can create a robust plan to fund your child’s college education.
College Savings Options
Many parents would like to start saving for college, but are unsure of where they should begin. Here are some different college savings options to consider.
1. Roth IRA
A Roth IRA is a tax-advantaged account designed for retirement savings, but you can also use it to save for college. Your investment will grow tax-free, and if you’re at least 59½, you can withdraw the money tax-free as well.
But if you’re under the age of 59½, you can make a penalty-free withdrawal of up to $10,000, as long as you use the money for qualified higher education expenses. The only disadvantage of choosing a Roth IRA is that your yearly income must be below a certain limit for you to be eligible.
2. Taxable Investment Account
A taxable investment account is a brokerage account funded with after-tax money. Your earnings will be taxed, but you can use the money for any purpose.
Of all the college savings plans on this list, a taxable investment account will be your most flexible option. And there are no income limits or caps on how much you can save every year.
3. 529 College Savings Plan
A 529 savings plan is a tax-advantaged plan offered by the state. Every state offers its own 529 plan, but you can open a 529 plan in whichever state you choose, as most states have no residency requirements.
The benefit of 529 plans is that your college savings will grow tax-free. You can also make nontaxable withdrawals, as long as the money is used for educational purposes. And many states even offer a state income tax deduction for contributions.
4. Coverdell Education Savings Account
Similar to a 529 plan, a Coverdell Education Savings Account is a trust or custodial account that you can set up for someone under the age of 18 to pay for qualified education expenses. You can invest up to $2,000 per year per beneficiary in various stocks, bonds, or other assets. It also grows tax-free.
However, unlike the 529 plan, your contributions are not tax-deductible. In addition, this plan is only available to people who make less than $110,000 for an individual or $220,000 for a married couple that files jointly.
When your child withdraws the money for college expenses, they won’t pay taxes on it. You can also use the money to pay for elementary or secondary education.
5. Prepaid Tuition Plans
A prepaid tuition plan is also similar to a 529 plan, except it allows you to “lock in” tuition amounts at their current rates. Essentially, the state guarantees that the funds will rise at the rate of college tuition inflation. College costs continue to increase every year, so this may be a suitable option for you.
The only downside is that more restrictions are put on prepaid tuition plans. For example, your child must attend either an in-state public college or choose from a select list of private colleges. And the funds can’t be used to pay for room and board.
6. Mutual Funds
While mutual funds are not specifically designed for saving for a children’s college education, they can still be a good choice if managed properly. Mutual funds are investment vehicles that gather money from multiple investors and invest it in a variety of securities, including stocks, bonds, and short-term debt.
One advantage of using mutual funds is that there is no cap on how much you can save. Additionally, you have the flexibility to use the funds for any purpose you choose. There are also a wide range of mutual funds available, with over 10,000 options to choose from.
7. Qualified U.S. Savings Bonds
U.S. savings bonds are debt securities issued by the Department of Treasury and are considered a safe, low-risk investment due to their backing by the U.S. government.
Some benefits of investing in savings bonds include federal tax deferral and state tax-free status. They also can be redeemed tax-free for qualifying higher education expenses.
However, there are some limitations to investing in savings bonds. The maximum investment allowed is $10,000 per year, per owner, per type of bond for individuals and $20,000 for married couples. Additionally, the interest exclusion for savings bond redemption for education expenses phases out for certain income ranges. If bond proceeds are not used for tuition and fees, the interest earned may be subject to federal income tax.
How to Save Money on College
If your child plans to attend college in the next year or two, you may feel like you’re running out of time to save for school. If that’s the case, your best plan is to find ways to save money so you can maximize the savings accounts you do have. Here are a few ideas to help you get started:
- Consider community college for two years: Having your child attend community college for two years can cut down on the amount of money you spend on tuition. Just make sure the four-year college they are planning to transfer to will accept all of their credits.
- Apply for scholarships and grants: There is no better way to cut down on the price of college than with grants and scholarships. If your child qualifies for grants and scholarships, that’s free money they won’t have to pay back after graduation. You can check out scholarship boards like Unigo and GoGrad to find possible scholarship opportunities.
- Fill out the FAFSA: Everyone who attends college should fill out the Free Application for Federal Student Aid (FAFSA). When you fill out the FAFSA, your child becomes eligible for financial aid and federal loans. Federal student loans come with lower interest rates and more favorable repayment terms than private loans.
- Graduate in less than four years: If your child is able and motivated to graduate in less than four years, this can save you a lot of money in tuition. Your child can do this by attending summer classes, choosing an accelerated program, and testing out of introductory college classes.
Summary
Planning and saving for your child’s college education can seem overwhelming, but starting early and being consistent are key. The earlier you start saving, the more time your money has to grow through compound interest.
Developing a plan is essential. Having a thorough understanding of the costs associated with college and using tools and calculators to estimate future costs can make this process manageable. Choosing the right savings option, such as Roth IRAs, 529 Plans, or Coverdell ESAs, will help you maximize your savings and take advantage of available tax benefits.
Consistently saving by setting up automatic contributions ensures regular savings, and adjusting your contributions as your financial situation changes helps you stay on track. Additionally, exploring financial aid options like scholarships and grants can significantly reduce the amount you need to save.
Don’t wait—start planning and saving today to ensure you can support your child’s future education. The sooner you begin, the easier it will be to reach your goals.
