Saving For College - Smart Money Habits For Easy Schooling
Savings for college is a smart move that not only supports school goals but also teaches good money habits that will make college easier. As families figure out how to pay for college, smart money management becomes more important than ever to make sure that education stays affordable and stress-free.
Author:Liam EvansReviewer:Habiba AshtonJan 08, 202410.1K Shares191.2K Views
Savings for collegeis a smart move that not only supports school goals but also teaches good money habits that will make college easier. As families figure out how to pay for college, smart money management becomes more important than ever to make sure that education stays affordable and stress-free. This article goes into detail about important ideas and suggestions that will help people and parents make smart choices and build financial safety for their children's schooling.
How Much Should You Save For College?
Determining the amount you need to save is the initial step in establishing a college fund. The urgency and quantity of savings depend on your child's current academic level. For instance, if your child is a high school junior, you'll need to save more quickly compared to starting when they are in first grade. Alternatively, you can gain a significant advantage by initiating college savings right after your child is born, as my wife and I did.
It's beneficial to have an idea of where your child might attend college, whether it's an in-state community college or a prestigious Ivy League university. However, this decision may not be clear until your child reaches the junior or senior year.
While there is often a substantial cost difference between public and private schools, it's essential to recognize that the quality of education may not necessarily correlate with the price tag. Choose an option that aligns with your student's needs and fits within your budget.
When Should You Start Saving For College?
If you find yourself on a tight timeline to save for your child's college education, it's crucial to grant yourself some understanding. The assumption that parents are solely responsible for covering college expenses doesn't always align with reality, as financial constraints may come into play. The truth is, your children can contribute to their college funds by securing grants, scholarships, or part-time employment (more details on that later).
For all parents out there, before delving into college savings for your kids, it's essential to set the stage for your financial success. This isn't selfish; it's a prudent approach, akin to the airline safety instruction to "put your mask on before assisting others." Follow these steps:
- Establish a starter emergency fund of $1,000.
- Eliminate all debt (excluding your mortgage) using the debt snowball method.
- Build a fully funded emergency fund covering 3-6 months of expenses.
- Invest 15% of your household income in retirement.
- Initiate savings for your children's college fund.
- Work towards paying off your home ahead of schedule.
- Focus on building wealth and contributing to charitable causes.
While step 5 may seem distant depending on your current financial situation, it's crucial to follow these steps in the correct order. Your child's college attendance or graduation is uncertain, but retirement is inevitable. Trust the process and prioritize these steps for long-term financial well-being.
How To Start A College Fund
After successfully organizing your finances and estimating the expenses associated with your child's college education, the next step is to initiate a college savings plan utilizing tax-advantaged options.
Establishing a college fund is a straightforward process, requiring you to identify the most suitable fund aligned with your savings objectives. Seeking guidance from a financial advisor can be beneficial in selecting an appropriate savings plan and navigating through available investment choices.
Education Savings Account (ESA) Or Education IRA
An Education Savings Account (ESA) operates similarly to a Roth IRA but is designed specifically for education-related expenses. With an annual contribution limit of $2,000 per child (after tax), the investment within the ESA grows tax-free. If you consistently invest $2,000 annually from your child's birth until they turn 18, your total investment would be $36,000.
The growth rate of an ESA depends on the chosen investments within the account. While the exact rate varies, investing in robust growth stock mutual funds with an average return of 10–12% could potentially result in the $36,000 investment growing to approximately $112,000 by the time your child reaches college age. This remarkable growth effectively triples your initial investment, alleviating concerns about tuition expenses.
The appeal of an ESA lies in its potential for a higher rate of return compared to a regular savings account, coupled with the advantage of tax-free withdrawals for education-related costs. Notably, an ESA isn't restricted to college tuition alone; it can also be utilized for K-12 private school tuition, vocational school, textbooks, school supplies, or tutoring. Moreover, should your child not require the funds, you have the flexibility to transfer the ESA to a sibling for their educational expenses.
529 Plan
If you aim to contribute more than $2,000 annually towards your children's college savings or don't meet the income criteria for an ESA, a 529 plan may offer a more suitable alternative. However, it's crucial to exercise caution, as not all 529 plans are created equal. Opt for a flexible plan that grants you the freedom to choose the funds you invest in.
Avoid prepaid 529 plans that lock in your tuition savings rate or automatically adjust your investments based on your child's age. Similarly, steer clear of fixed or life-phase plans that limit your control over mutual funds. It's essential to maintain control over your investment choices.
Similar to the ESA, the 529 plan extends its utility beyond college tuition, covering expenses such as K-12 education, vocational school, or necessary college textbooks. Some 529 plans even permit the transfer of funds between family members, offering flexibility in case the intended beneficiary decides not to pursue higher education. However, it's crucial to note that not all 529 plans allow this transfer option.
UTMA Or UGMA
If you have already explored options like ESA and 529 plans or don't qualify for an ESA, you may consider looking into a Uniform Transfer to Minors Act (UTMA) or a Uniform Gift to Minors Act (UGMA). These plans differ from ESAs and 529 plans as they are not specifically designed for college savings.
In a UTMA or UGMA, the account is established in the child's name but remains under the control of a parent or guardian until the child reaches either age 18 or 21, depending on state regulations (typically age 18 for UGMA and age 21 for UTMA). At the designated age, the child gains control over the account and can use the funds as they see fit, essentially creating a mutual fund in their name.
These funds don't impose limits on the amount of gift money contributed, but exceeding $18,000 per year (or $36,000 for a married couple) may incur federal gift tax.
While UTMA or UGMA accounts offer a tax-efficient way to save for college and invest in your child's future, it's important to note that the child has the ultimate decision-making authority on how the funds are spent. This could lead to scenarios where, at age 18, they might opt for purchases like vintage guitars and an abundance of plaid western snap-button shirts, a phase many individuals go through.
Simple College Savings Tips For Students
Many parents aspire for their children to pursue a college degree, recognizing it as a privilege rather than a mandatory path. However, it's important to acknowledge that college isn't the right choice for everyone.
If your child decides to pursue higher education, it's crucial to understand that paying for college is not solely the parent's responsibility. Encouraging your child to take ownership of their education and finances can be empowering. Even as a full-time student, they can initiate savings and cultivate healthy money habits that will benefit them in the long run.
Here are some college savings tips to assist your student in financing their education:
Apply For Scholarships
Encourage your child to actively seek scholarships, which are essentially free money for college that doesn't need to be repaid. Whether excelling in athletics, academics, or extracurricular activities, they should leverage their strengths to pursue and apply for various scholarships regularly. Even smaller scholarship awards can accumulate significantly over time.
Apply For Aid
Ensure that everyone aspiring for college fills out the Free Application for Federal Student Aid (FAFSA). This form helps schools determine the financial assistance they can offer students. The FAFSA opens doors to federal grants, work-study programs, state aid, and school aid—all forms of free financial support. However, caution is needed, as the FAFSA also outlines the potential for student loans. Carefully review the award letter to ensure it includes scholarships or grants and not loans.
Take AP Classes
High school students can explore Advanced Placement (AP) classes to earn college credits while still in high school. Credit transferability depends on AP test scores and the policies of the chosen college.
Although a small fee is typically associated with these classes, it's considerably less than the cost of a college class. To find available AP classes, students can speak with their academic counselors, and dual enrollment courses offered by nearby community colleges are another option.
Get A Job
Whether through a full-time summer job or part-time employment during the school year, students can save money for college and gain valuable work experience for their resumes. Engaging in various roles, from mowing lawns to lifeguarding, contributes to both financial savings and professional development.
Open A Savings Account
Provide your students with a secure place to manage their earnings from part-time jobs by opening a student checking account, typically available at most banks. These accounts often include a debit card and savings account, with no monthly maintenance fees or minimum balance requirements. If your child is under 18, you can be a joint account holder, facilitating their introduction to saving, spending, and budgeting.
Emphasize Saving Over Spending
Encourage your child to promptly deposit a portion of their earnings into their savings account to resist the temptation to spend it all. Consider implementing a matching incentive, where you agree to match their savings dollar for dollar, motivating them to save even more.
Avoid Student Loans
Eliminate the option of using student loans altogether. While they may seem like a quick solution, they often lead to long-term debt for college graduates. If your child cannot afford tuition upfront, explore alternative solutions such as transferring schools, taking a semester off to work and save, or finding other financial avenues. Prioritize avoiding student loan debt.
Opt For A Cost-Effective School
While Ivy League schools may be appealing, consider the financial benefits of choosing an in-state school that offers similar degree programs at a significantly lower cost. Staying local reduces moving expenses, out-of-state tuition, and travel costs to visit family and friends.
Live At Home
Encourage your child to live at home and commute to college, potentially saving thousands annually on room and board expenses. Additionally, they can opt out of the campus meal plan, saving money by cooking at home or participating in family dinners. Living at home doesn't mean missing out on campus life, as your child can still join clubs and engage in campus activities.
Explore Tuition Reimbursement At Work
Guide your child in searching for part-time jobs with companies that offer tuition reimbursement benefits. Some employers provide financial support for their college student employees, offering both monetary assistance and valuable professional experience for their resumes. Every bit of assistance counts in managing college expenses.
Costly Mistakes To Avoid
Assuming Your Money Will Grow
While commonly referred to as a college savings account, a 529 plan shouldn't be misunderstood as a guaranteed savings vehicle. Similar to a 401(k), the growth of your money is not assured, and the performance of your plan relies on your investment choices and market conditions.
It's crucial to recognize that the value of your investments within a 529 plan can fluctuate, and there is a potential for loss. Additionally, the impact of inflation can erode your purchasing power, meaning that your investments might not keep pace with the rising costs of college.
To manage these risks, consider initiating a 529 plan early, providing more time to potentially recover from market downturns. Selecting a diversified portfolio aligned with your risk tolerance and time horizon is essential, and leveraging the potential benefits of compounding growth over time can help safeguard against the uncertainties associated with college funding.
Neglecting Asset Allocation And Savings Adjustment
When selecting a 529 plan, you'll typically choose between age-based or static portfolio allocation. An age-based portfolio starts with a higher proportion of stocks than bonds in the child's early years and gradually shifts to a more conservative mix as college enrollment approaches, resembling a target-date fund.
On the other hand, a static portfolio allocation maintains the chosen asset mix, requiring you to periodically rebalance and adjust the allocation as needed. Common advice suggests reducing stock allocation as college nears, aligning with many investment strategies.
While setting up automatic 529 contributions streamlines the process, it's essential not to become complacent about your savings goal. Consider increasing contributions as your income grows, especially if you begin with a modest amount. Additionally, supplement regular deposits with occasional contributions from gifts on occasions like birthdays or holidays from friends and family.
Missing Your Contribution Deadline
In many states, contributions to 529 plans need to be completed by December 31 to be considered for the current year regarding gift tax implications. However, if your 529 plan provides a state income-tax deduction, the deadline for contributions for income-tax purposes may extend until mid-April of the following year.
Withdrawing Funds Too Late
Once your child commences college and the invoices begin arriving, it's crucial to withdraw only the funds necessary for qualified college expenses within that calendar year. This is especially relevant for tuition bills received in December but with a due date in January.
If you settle the entire tuition bill before the year concludes, it's essential to withdraw the funds in December; otherwise, the distribution might be considered unqualified. Alternatively, you can wait until January to make the payment, but in doing so, ensure that you delay withdrawing the funds from the 529 until then.
Additionally, only submit qualified expenses for 529 plans if there are no other tax-advantaged sources or scholarships that already cover them. This ensures accurate utilization of the funds and maximizes their benefits.
Withdrawing Unnecessary Funds From Your Child's Account
If your child secures a full or partial scholarship for college, consider withdrawing an equivalent amount from the 529 plan. Although the typical 10% penalty on nonqualified earnings distributions is waived, the withdrawn amount will be subject to ordinary income tax. You can still use the remaining funds for legitimate expenses that the scholarship does not cover.
In cases where some college expenses don't qualify, there are strategic options to avoid unnecessary taxes and penalties. For instance, leaving the money in the plan for potential tax-deferred growth, especially if your child plans to pursue an advanced degree, can be advantageous.
Alternatively, changing the beneficiary is a viable option. Switching to other children, grandchildren, or eligible family members can be done without incurring penalties or taxes, provided the change is made before the child starts college.
Under SECURE Act 2.0 starting in 2024, a rollover of up to $35,000 from a 529 into a Roth IRA for the beneficiary will be allowed. Certain conditions apply, such as the account being open for at least 15 years, and rollovers are subject to Roth IRA annual contribution limits. Additional details from the IRS are expected in the coming year.
Saving For College - FAQ
What Is The Best Amount To Save For College?
It's hard to know exactly how much to save for college for every parent, but one-third of a four-year program's tuition and fees is an excellent place to start.
How Can Students Save Money?
Cut back on eating out and instead make your meals and coffees. Shop smart by buying generic brands instead of name brands, too. Rent or buy used textbooks rather than buying them brand new. Your university bookstore might have used books, or check Amazon.
How Much Do Most Parents Save For College?
Americans seek to save $55,342 on average for their children's college expenses. On average, parents expect to pay roughly 30% of their child's college expenses. On average, parents pay 10% of their child's college expenses.
Final Words
Mastering the art of saving for college makes the path to a smooth education possible. Individuals can handle the costs of higher education by practicing smart financial planning. This way, money issues won't get in the way of their quest for knowledge. Developing good money habits is an investment in both education and financial well-being when we help the next group of students do well in school.
Liam Evans
Author
Habiba Ashton
Reviewer
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