Every time I think about how much college will cost us, my mind freezes over into a “does not compute” mode. How is it possible that the cost of college has become greater than the average mortgage in the U.S.? DOES NOT COMPUTE.
Get this – according to The College Board, we will have to find either $623,273 or $316,582 to pay for our girls education depending on if they choose a private college or an in-state public university.
It makes me want to curl up in bed and wish these expenses away.
But unfortunately I can’t.
So How Does One Begin to Save for College?
Of course, two-thirds of families will qualify for financial aid. And at least 70% will take out loans.
But for many families neither of these options will cover all the costs. Many of us will need to save – either a lot or a little. And even if a family does qualify for loans, there’s usually the desire to avoid as much student debt as possible.
When to Start Saving for College
First of all, I am not a certified financial planner, even though I do have a certificate in financial planning and an MBA. I have also done a lot of research on saving for college over the years. One thing I’ve found is that while saving for your child’s college education is among the most generous gift you will give him or her, there’s a right time to begin saving:
1. Pay Off Credit Card Debt First: Don’t begin saving for anything until you’ve paid off any high-interest credit card debt or you’re able to roll that debt into a product with a lower interest rate. With credit card interest rates higher than the return on most investments, you’d be working against your goal if money was put towards savings instead of paying down debt.
2. Begin Saving for Retirement First: If worse comes to worse, college can be paid for with loans. Retirement can’t. Even if by paying for college you initially help your kids reduce their loans, they may end up in a worse financial state if they have to fund your retirement. Also note that retirement savings aren’t used in financial aid calculations so there’s no need to worry about saving too much.
3. Take Advantage of Employer Matches: Meaning, if your employer offers a 401K, 403B or similar retirement plan and also offers to “match” or in other words, help contribute to your retirement, take advantage of it! Don’t leave free money on the table. Stop reading this and sign up for that plan now. With a 100% return, funding a matched retirement plan is quite possibly the best investment you’ll ever make.
You’re Ready to Begin Saving for College, Now What?
If you’ve paid off your credit card debt and are contributing to a retirement fund, the next thing to ask is: What’s the best way to begin saving for college?
Open a 529 Account…a 529 What?
Despite it’s strange name (thank the internal revenue service for naming products after the internal revenue code), 529 accounts are savings plans that allow parents to set aside money for college. Every state and a few other institutions offer 529 savings plans (as well as prepaid plans, but I won’t get into those here). Like most investment products, 529 accounts have benefits and potential drawbacks. Read more about 529 plan rules here.
1. Tax-free investment growth: Unlike regular mutual funds, which can be hit with capital gains taxes when money is withdrawn, 529 accounts do not incur taxes. This is the leading benefit of 529 accounts.
2. Potential tax breaks in certain states: 33 states offer tax breaks if you invest in your state’s plan. An added benefit if you live in one of these states.
3. No income restrictions: Anyone can open an account regardless of income
4. High contribution limits: Families can make annual contributions of $14,000 for individuals, $28,000 for married filing jointly.
5. Low minimums for opening an account: Anyone can open an account for as little as $15.
1. Withdrawals can only be used for higher education: You will have to pay a penalty to the federal government if money is spent on other expenses, but it is possible to transfer a 529 from one dependent to another, use it for graduate school or pay for a parent’s education.
2. High fees: Fees on some 529 plans can be higher than regular mutual funds, so research carefully.
3. Parent’s assets, including a 529, decrease financial aid: Money placed in 529s (or any savings account except retirement) can lower federal financial aid (but not by much).
4. 529s May Impact a School’s Financial Aid: Many schools are starting to adjust the awards they give independently when they discover 529 accounts in the family.
A Little Known Fact About 529s:
You don’t need to sign up for your state’s 529 just because it’s your state: The main reason to consider your state’s 529 account is if there is a tax advantage. If there’s not, you might want to look elsewhere. I live in Massachusetts but we signed up for Utah’s 529. Utah’s 529 is run by Vanguard, a major provider of index funds, and since I only invest in index funds, Utah’s 529 made the most sense for us. The account’s low fees are also attractive.
Where to Find the 529 That’s Right for You:
- The first thing to check is whether your state offers tax breaks for contributing to a 529. Find that out here. Morningstar suggests that if the tax break is greater than 5% it probably makes sense to stay in-state, but if not, it might make sense to look elsewhere.
- If you plan to look outside of your state, the next step would be to look at Morningstar’s Best 529 College Savings Plans. Start at the top with the gold-rated funds and work your way down. When looking this over consider:
- Do you want to manage the investments in your 529 or do you want investments that automatically adjust in riskiness as your child gets closer to college age? This is the difference between static and age-based plans.
- Do you want to have index funds or managed funds in your portfolio?
- Check the fees: fees can eat into investment growth and make a big difference to your final savings. Even 529s that have index funds, which are generally known to have lower fees, can be expensive.
For More Information, Check Out These Resources:
- NPR: Confused How to Save for College? Here are Answers
- Morningstar’s Best 529 College Savings Plans
- Morningstar: How to Choose a 529 Investment
- Saving for College.com
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