Saving for College
The thought alone can cause a feeling of anxiety and stress for a lot of parents. When the kids are born, most parents have the best intentions, but often, money is tight or feels that way. Saving for college is then put off until the kids enter school or even later sometimes.
I’m not here to judge. It’s completely understandable. You have numerous financial objectives and it can be tough to decide which to prioritize.
Before you know it, years pass by and you realize you haven’t saved as much as you wanted to. Then you see the cost of college and you wonder how anyone can ever save enough.
Costs are skyrocketing.
According to educationdata.org, “The average cost of college in the United States is $35,720 per student, per year. The cost has tripled in 20 years, with an annual growth rate of 6.8%.” In fact, the average in-state tuition runs about $9,580 and that’s just tuition! The average in-state student spends over $25,000 a year to attend college, factoring in total costs including things like books, expenses, and board.
You may be looking at your savings wondering how and where you will find over $100,000 for each of your children (and if they’re babies right now, add six-seven percent to that for every year they have before they go to college.)
But don’t get discouraged.
You can save for college and work toward your other financial goals! You just need to create a plan and understand the college savings tools at your disposal.
What Should I Know About Saving for College?
First, let’s go over a few things about saving for college before we get into the college savings tools.
- There are certain account types with beneficial features that are created specifically for education savings.
- Although you want to help your kids, you can always borrow for college costs. You can’t borrow money to live on in retirement.
- Hoping for a sports scholarship for your child is not a college savings plan, no matter how gifted your child is.
- There are a lot of options out there. Many people ask friends what to do. But what worked for them, may not be the best solution in your situation. A financial advisor who looks at your life and spending habits can provide a much clearer view of the best approach for you.
What Is the Best Way to Save for College?
There are several options out there and we’ll explore the factors that go into figuring out the right college savings vehicle for you. In the section below, we’ll cover the pros and cons of using each college savings tool. Keep in mind, that you needn’t choose one over another. Many families use a combination of savings options.
529 Accounts: Tax-Free Growth
A 529 account was created specifically for education savings. It has long been strictly for college, but recent changes now allow these accounts to be used for up to $10,000 per year, per beneficiary, for grades K-12. A 529 can also be used for the benefit of an immediate family member. On those delightful occasions when a student receives a full-ride, parents have the option to apply the 529 to another child, save it for advanced schooling such as a masters or additional training, or use it for themselves to pursue a class (or two) in something of interest to them.
Many states offer 529 accounts, and the investment options often consist of an age-adjusting portfolio option. This is a hands-off investing approach with higher growth investments (e.g., stocks) when the child is very young, which becomes more conservative as the child approaches college age. Your money grows over time, but you’re also reducing risk closer to the time to pay for college. Each states plan is unique and may have different options, so be sure to find a 529 plan that is best for you. You do not need to use the plan for your state, but if you use a different states plan then you may miss out on tax savings.
Benefits of a 529:
- Tax deferred growth
- Tax deductible contributions in some states if you are using your states plan
- Tax free withdrawals on qualified education expenses
- Ability to transfer accounts between immediate family members tax-free
- No contribution limits set by the IRS if certain requirements are met.
- You can have multiple 529s
- Other people can contribute for you too
Cons of a 529:
- Investment options may be limited
- Funds distributed for non-qualified expenses are subject to income tax and a 10% penalty on earnings
- One beneficiary at a time per 529
Custodial Accounts (UGMA/UTMA)
Custodial accounts are another savings vehicle designated for children. Custodial accounts are not education specific, and the account becomes property of the child once they reach the age of majority. These accounts may be subject to taxes.
Benefits of a Custodial Account:
- It can be used for any type of expense, not just education
- Wider range of investment options
Cons of a Custodial Account:
- May be subject to tax at either the parent’s level or the child’s level
- Account has to be turned over to the child’s ownership upon them meeting the age of majority – typically 18 or 21
Roth IRAs provide a way for parents to save for their own retirement, but also be able to tap into the funds with no penalty should they need to for college. However, there are income and annual contribution limitations. For 2021, you can contribute up to $6,000 a year ($7,000 if you’re age 50 or older) to a Roth IRA.
Benefits of a Roth IRA: again, you can’t borrow for retirement, so I often suggest clients worry about their own retirement first. This approach allows for both at the same time.
- Once you reach 59½, all Roth IRA money can be withdrawn tax and penalty free to help with children/grandchildren's expenses
- Contributions (not earnings) can be withdrawn at any time—income tax and penalty free
Cons of a Roth IRA:
- Contribution limitations
- Use of Roth IRA funds for education expenses reduces the money available for your retirement
- No state income tax deduction for contributions
- Roth withdrawals count as income and may affect financial aid eligibility
While this is not a savings vehicle, it is something parents and guardians should consider when saving for college. The reality is, if you must decide between saving for your own retirement or your children’s education, your retirement is a more dire situation. However, parents should discuss their feelings about student loans ahead of time. Be open with your children and use this time to teach them good financial habits so that paying the loans off will not become a hardship.
Benefits of student loans: they are there if you cannot cover the entire cost of college with what you’ve saved. More and more families are simply using savings to offset the costs, not cover them entirely. These loans can be a way for your student to attend their dream school and learn financial responsibility.
Cons of student loans: The average student takes 21.1 years to pay off their student loans. This can mean high interest rates, penalties, and other difficulties in repayment. Students may get approved for more than they can pay off as a new graduate.
How Much Do I Need to Save for College?
As mentioned earlier, there’s tuition and total cost of attending college. The average private school tuition for four years is about $140,000. In state, public school tuition will be around $40,000 for four years. You don’t need to save that amount as financial aid packages, scholarships and grants may be available, and you may be able to pay some of the college expenses from income. However, these are good numbers to keep in mind.
Most college savers target one-third of the costs of their desired college type as an initial goal keeping in mind that college costs have increased an average of 6.8% annually over the last 20 years. We’ll have to see what effect COVID has on that. While fewer students were enrolling in college during the pandemic, some states, like California, saw a large increase in state school applicants in 2021, making the process much more selective. This may change the rate of increase in tuition. Although even if it did, it would probably only do so nominally. Still, we’ll watch for it, and continue to save like before.
How Do I Start Saving for College?
If you want to help offset (or pay for) the cost of college for your children, setting up the structure is the best way to do it. Keep the following college savings advice in mind:
- Start early. Your money will have longer to grow if you begin when your children are babies. If you don’t have the funds to save when they are infants, encourage friends and family to help you contribute to your fund instead of buying toys or clothes that the children will soon grow out of.
- Be structured. The best savings and growth will occur when you are consistent about your contributions. Having money auto-deposited from your paycheck is the best way to contribute consistently.
- Add extra money. Sometimes you find money, receive an unexpected bonus or refund, or are gifted something you weren’t expecting. Since that money is not factored into your budget, consider putting some (or all) of it in the college savings account. It’s money you won’t miss.
Paying for your children’s college can seem daunting. However, when you select a strong college savings vehicle that suits your goals and you make saving a priority, you can maximize your money over several years. A financial advisor can not only help you select the best way to save for college depending on your lifestyle, they can also examine areas of your budget and finances to help you maximize and achieve other financial goals.
Schedule a call today to learn how Crest Wealth Advisors may assist in creating a college savings strategy that takes into account your other financial objectives.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Jason Dall’Acqua, and all rights are reserved.