Saving for College: When to start, 529 plans, scholarships + moreChristina Couch
Think it’s too early to start saving for your kid’s college fund? Think again. According to the financial aid website Finaid.org the average cost of college for babies born this year will more than triple by the time they get there.
Fortunately, there are steps you can take now to prevent a college cash catastrophe years down the road. Parents who start a college savings plan early wind up with more savings, more compound interest and significantly lighter tuition bills than parents who wait even a few years. Here’s what you need to know to put yourself in that enviable position:
1. Start Now
As a new parent, the best thing you’ve got on your side right now is time. A family who invests just $50 a month in a child’s 529 plan (see #3 below) starting when he or she is born should have more than $17,500 by the time that child is ready for school (assuming a 5 percent annual rate of return). Parents who invest the same amount but start just five years later will have $6,000 less. Investing money you would have spent on those extra toys or that super cute holiday outfit can translate to an extra year of education when your child is in college.
2. Step Away From the Savings Account
Stashing your kid’s college cash in a traditional savings account just isn’t going to cut it for two reasons: First and foremost, savings accounts generate abysmally low interest rates, so you’ll accrue almost no cash on top of the principal; secondly, funds stored in a savings account in your child’s name will substantially reduce your child’s eligibility for federal grants and scholarships down the road. Instead of investing funds in a low-interest-bearing savings account, choose one of the options below.
3. Open a 529
Now that you’re skipping the savings account, check out your state’s 529 plans instead. Available in all 50 states and the District of Columbia, 529s come in two forms: Some are college savings plans that allow parents to pick a portfolio of stock and mutual funds that respond according to fluctuations in the stock market; others are prepaid plans that allow parents to buy college credits at today’s rates then cash them in when the child is ready to attend school. Both plans allow parents to maintain control of the funds, meaning that if your kid decides he’d rather tour with his band than go to college, he can’t use your college savings to do so. Funds grow tax-deferred (on the federal level) and, if used for qualified education expenses, can be withdrawn tax-free. Some also offer additional state tax incentives. But be careful, there are catches. 529 funds can only be used at accredited U.S. educational institutions, and funds must be used for educational expenses. Otherwise the plan owner pays a 10-percent penalty on earnings. Parents can invest in any state’s 529 plan, whether or not they actually live in that state, so be sure to shop around, compare each plans’ past performance and contrast the fees. If your child decides not to attend school at all, funds can be rolled over to another child’s name or can be used for educational expenses for yourself.
4. Go for Matching Grants
Here’s another good reason to invest in a 529 plan: Some states will match a portion of your contributions. Minnesota, Louisiana, Utah, Colorado, Arkansas, Nevada, Rhode Island, Kansas, Maine and North Dakota all provide a financial match for residents who invest in 529 plans in that state. Most matching grant programs operate like a college savings version of employer 401K matches: Parents invest a certain amount – usually somewhere between a few hundred and a few thousand dollars – and the state government kicks in to match anywhere from 33 percent to 100 percent of that investment, depending on the state. Matches come with caps, but most participating states will contribute somewhere around $500 to $600 of free money toward your college savings. Note that several matching programs only apply to low- or middle-income parents.
5. Make Saving Automatic
Parents who save the most pay themselves before anyone else. As soon as they get their paychecks, money immediately goes into savings before getting doled out to bills, groceries or anything else. According to a survey by electronic-payments company NACHA, parents who automatically deposited a portion of their checks saved an average of $90 more per month than those who didn’t. Invest that $90 per month ($1,080 per year) into a 529 plan with a 5-percent average annual interest rate starting when your child is born and you’re looking at more than $31,000 in savings by the time Junior is ready for college.
6. Enlist the Family
Grandparents, relatives and even family friends can contribute to your child’s 529 plan or open a plan of their own in your child’s name. The advantage to having multiple 529 plans in your kid’s name is that when it comes time to apply for financial aid, the federal government will look at how much you’ve saved for your child but won’t take into consideration plans opened by other family members. 529 plans also come with gift tax exemptions that allow generous benefactors (a.k.a. aging relatives) to invest up to $13,000 in your child’s plan at once without paying hefty tax penalties.
7. Take Care of Yourself First
Before contributing a dime to your child’s 529 plan, get out of credit card debt. It doesn’t make any sense to put money into a college savings plan while you’re paying astronomical interest rates on your credit cards. If you’re already debt-free, congratulations! Before contributing to your kid’s 529 plan, make sure you can pay the mortgage on your primary home and max out your retirement savings. Putting funds toward these two things first will keep your family out of financial trouble and raise your child’s scholarship eligability down the road.
8. Don’t Let the Numbers Scare You
If the cost of college keeps increasing the way it has, higher education for your baby is going to be expensive. According to the College Board, a child born today will pay $65,530 for their freshman year at an in-state public college or university. Assuming an annual 529 return rate of 6 percent, which is modest with many plans, parents would need to save about $750 a month from a child’s birth to cover the entire cost of public college – yikes!
Obviously that’s not possible for many families, but the good news is that financial options including scholarships, grants, loans, loan forgiveness programs and work-study jobs are available to help with the rest. While the government doesn’t expect parents to foot the entire cost of college alone, it does require parents to pitch in a hefty amount. Save often, save early and, whatever you do, don’t worry about getting less aid because of your savings. While it’s true that the government does take your savings into account in assessing how much you are able to pay, only 5.6% of your savings is considered an eligible part of your contribution.
9. Help Your Child Succeed
Hands down the single best thing parents can do to help their children pay for college is encouraging them to succeed in school while they’re young. Early education research shows that kids who are prepared for kindergarten and who master grade-level reading throughout elementary school are more likely to attend college and achieve honors than those who don’t. Contributing time to helping your kid understand reading fundamentals is just as, if not more, important than contributing to his or her college fund.