A college degree, considered one of life’s greatest achievements, does not come without a price tag. During the 2020 through 2021 academic year, the average annual cost of attendance for college was $38,070 at private colleges, $10,740 at public colleges for in-state residents, and $27,560 at public colleges for out-of-state residents. When you add in room and board, these prices jump up an average of $13,620 for private colleges and $11,950 for public colleges.
As a parent or grandparent, paying for college can feel like a daunting task. Luckily, saving up enough money to send your child to the school of their dreams doesn’t have to keep you up at night. Most financial advisors are well-versed when it comes to saving for college and can recommend a variety of different saving options that best suit your goals and lifestyle. Keep reading to learn about just a few of our advisors go-to methods for saving for college.
When To Start Saving for College?
This may seem obvious, but it is never too early to start saving for college. According to a recent report by Georgetown University’s Center on Education and the Workforce, between 1980 and 2020, the average price of tuition, fees, and room and board for an undergraduate degree increased by 169%. This steady, consist rise in costs means the more time you have to save, the better.
If you know you are going to have children or grandchildren, start saving before they are even born. Why? If you wait to start putting money aside for higher education, you’ll find yourself getting stretched thin with all the competing costs that come with have a young child. Time off work, daycare costs, medical care, clothing, diapers —these unavoidable factors make setting money aside that much harder.
Another advantage of starting to save for college early is the benefit from compounding, which is the process of earning additional funds on the interest and/or capital gains that your investment earns along the way. With smart, consistent investments spread over multiple years, you may be surprised at how much you’ll be able to build up for your child's college fund.
How Much Should I Save for College?
The first step when deciding how much to save for your child’s college education is determining how much of their bill you want to fund. The more you save, the less they will have to pay or borrow in the future.
If you want to cover 100% of their college cost of attendance, including tuition, fees, room and board, books, transportation, and personal expenses, you’ll need to save significantly more than if you just wanted to provide them a launching off point.
In 2017, Fidelity Investments created the 2k rule of thumb to help parents stay on track to cover half the average cost of a four-year, public university. The basic principle is simple: multiply your child’s age by $2,000 to figure out how much you should save. More simply, on average you will need to save $2,000 every year of your child’s life to be ready to cover roughly half of their college cost of attendance.
Though this may serve as somewhat of a guide for the 69% of parents that wish there were more specific guidelines on how much to save for college, it does operate under one major assumption: you have a 529 plan.
How Should I Save for College?
There are multiple ways parents and guardians can approach saving for their child’s college fund. Mutual funds, bonds, Roth IRAs, and 529 plans are just a handful of methods financial advisors recommend you explore when beginning your investing and saving journey. What are the benefits of these financial strategies, though, and how do they differ?
A 529 plan is a state-sponsored, flexible, tax-advantaged account designed specifically for education savings. Funds from a 529 plan can be used for qualified education expenses nationwide.
There are currently two main types of 529 plans: prepaid tuition plans and education savings plans. Prepaid tuition plans let you purchase units or credits at participating colleges and universities for future tuition and fees at current prices for the beneficiary. It should be noted that a prepaid tuition plan does not typically cover future room and board and cannot be used for tuition at elementary or secondary schools.
An education savings plan lets you open an investment account to save for a beneficiary’s future qualified higher education expenses, including tuition, fees, and unlike a prepaid tuition plan it can go toward room and board as well.
Additionally, an education savings plan can be used to pay up to $10,000 per year per beneficiary for tuition at any public, private or religious elementary and secondary school.
Mutual fund is a term that refers to a company that pools money from multiple investors and invests the money in securities such as stocks, bonds, and short-term debt. If properly managed, a mutual fund can be an excellent way to save for your child’s future schooling. Although they aren’t specifically designed for education saving like a 529 plan, mutual funds do come with their advantages:
- There’s no limit to how much you can save.
- Mutual funds typically invest in a range of companies and industries, which lowers your risk if one company fails.
- You can spend the money on anything you want.
- As of 2020, there were 7,636 available mutual funds in the United States.
Qualified U.S. Savings Bonds
Series EE and Series I U.S. Savings Bonds, which are available from the U.S. Treasury Department, offer a low-risk and modest-return investment for college saving. One of the greatest benefits of a U.S. Savings Bond is that as long as the bonds are used exclusively to pay for qualified college expenses, the interest earned is generally free of federal, state, and local taxes. There are, however, a few conditions that must be met in order to use Series EE and Series I as tax-free funding for college:
- The funds are used for qualified educational expenses which include tuition and fees. Note: books and room and board are not qualified expenses.
- The expense occurs in the same tax year in which the bonds are redeemed.
- Both the principal and the interest from the bonds are used.
- The qualified education expenses have not already been covered by financial aid, scholarships, 529 accounts, Education Savings Accounts (ESAs), or other tax breaks.
- Your filing status is not married filing separately.
It is also important to note that if the bond redemption exceeds the amount used for educational expenses, the remaining interest will be taxed as regular income on a prorated basis.
When most of us here Roth IRA, we think of a retirement fund, however, a Roth IRA can also serve as a great way to pay for college. Since there is no income tax deduction when you contribute to a Roth IRA, your contributions and earnings grow tax free. And because you’ve already paid your taxes, you can withdraw contributions at any time, for any reason, tax free.
If you’re under the age of 59½, withdrawals of Roth IRA earnings are subject to income tax, but not an early withdrawal penalty if the cash is used for college expenses. Once you reach age 59½, however, all of your withdrawals—earnings and contributions—are tax free. This means that 100% of your withdrawals can go to paying off college expenses.
Coverdell Education Savings Account (ESA)
For many, Coverdell ESAs are considered one of, if not, the best option to save for a college education. This tax-deferred, flexible trust account can be used to pay for elementary, secondary, and higher education expenses and covered not only tuition and fees but room and board as well.
Another benefit of a Coverall ESA is that the earnings accumulate tax-free, and distributions are free of income taxes as long as the funds are used for educational purposes.
Work With a Professional to Start Saving for College
According to a 2016 study, 41% of families work with a financial professional to save for their child’s college education. If you are overwhelmed at the thought of starting a savings for your child’s education, or maybe you just need some guidance on how to get started, our advisors are here to help. Contact us to learn more about our investment and planning services.
Preparing for college means setting goals, staying focused, and tackling a few key milestones along the way, let JL Smith help you get started.