What Every Parent Needs to Know About Saving for Their Child’s College Education

Depending on your little one’s age, college might seem like a virtual lifetime away; however, it will creep up on you much faster than you think. In fact, if you aren’t careful, it may catch you completely unaware. While it may sound like a cliche, it is never too early to start saving for college. Yes, it is nice to think that your child will get an athletic or academic scholarship that will take care of such a huge expense but it is best not to count on that. Start saving for college for your child now and if he or she does end up with a scholarship you’ll have the pleasant windfall of a nice chunk of change.

Why is it so important to start saving for college? A recent study by Georgetown University found that by 2020 over 65% of new jobs in the U.S. will require a college education. Think about it, 2020 really isn’t that far away. Obviously, the sooner you start saving for college the easier it will be to reach your goal. Investing just $100 a month for 18 years will yield $48,000 (assuming an 8% average annual return). While that wouldn’t totally pay for your child’s college education at a 4 year university it will definitely help!

Saving for college can be intimidating and confusing. There are a lot of options and it can be difficult to know which is best for you. To help you find the solution that is best for you and your family as well as meet your goals, here is what every parent needs to know about saving for their child’s college education.

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What Every Parent Needs to Know About Saving for Their Child’s College Education

The very first step to saving for college is figuring out how much money you’ll need. The younger your child is the more complicated this can be. First off, there’s a pretty darn good chance college tuition will continue to increase over the years. You’ll need to try to predict at what rate it will increase so you know how much to invest and put away. In addition, if your child is young, it’s impossible to know what he or she will really want to be when they “grow up”. Cowboy probably isn’t a viable career. 🙂 Since you can’t ascertain this information knowing what type of college (private vs. public) is also impossible. The best thing to do is plan for the worst (most expensive) and save as much as your budget and lifestyle will permit.

Luckily you aren’t alone. There are tools to help you determine how much you need to save for college like this college planner. This college planner takes into consideration college costs, your child’s age, your tax rate, current savings and expected contribution to determine if you’ll meet your college savings goals.

In addition to plain old savings accounts, there are plenty of other ways to sock money away for college tuition. Of the many college savings plans, this article will primary focus on Savings 529 Plans since they are not only popular but offer numerous advantages. For example, with a 529 Plan your eligibility is not effected or restricted by your income. No matter how much or little you make you can open and contribute to a 529 Plan. Let’s dive in by defining what exactly a 529 Plan is. Here are the two different types of 529 Plans available to you:

Prepaid 529 Plans

This type of 529 Plan allows you to pick an educational institution and pay a set tuition rate now for your child to attend the school later. This is a state-sponsored investment program so your options (and how good the program is) will vary from state to state. Each state sets up a plan with an asset management company and that is who you will open an account with and deal with for your 529 Plan.

Some states will allow you to pay whatever the tuition rate is right now; however, many others (Florida, Illinois, and Washington to name a few) require you to pay a higher tuition than the current rate with a Prepaid 529 Plan. Furthermore, some states Prepaid 529 Plan’s cover room and board; however, most do not. The lifetime contribution limit and the minimum amount you must invest each month will also differ from state to state.

All of these differences mean that when investing in a Prepaid 529 Plan it is important to thoroughly research your state’s plans. Learn more about prepaid 529 plans to determine if this is a wise investment decision for saving for your child’s college education.

Savings 529 Plans

This type of 529 Plan allows you to invest money in a tax-deferred account that is later used to pay for college tuition. The great thing about this type of 529 Plan is that it can be used at any school meaning you don’t have to pick your child’s college in advance. In addition, with this type of 529 Plan, the money can be used for any college related expenses like room and board.

With Tax-Deferred 529 Plans, you are the owner of the account and your child is the beneficiary. Anyone (regardless of relation) can contribute to this 529 Plan making it a great birthday, Christmas, or other gift. Plus when your little one goes to put his Tax-Deferred 529 Plan into use, he won’t have to pay federal taxes (as long as the money is used for a qualified education expense). Yep, the account earnings are exempt from federal taxes.

In addition, in many states, 529 Plans’ earnings are tax-deferred and you may even be able to deduct part of your contribution from your state taxes each year. What if your child decides not to go to college? No worries! With a Tax-Deferred 529 Plan, there is a lot of flexibility in how your money can be used. You can change the beneficiary to another child in your immediate family. You could also roll the money into a different qualified investment product or even withdraw the money and use it for whatever you’d like. Note that if you do withdrawal the money for non-educational purposes you’ll have to pay taxes on the money and a 10% federal penalty.

Which Savings 529 Plan is right for my child?

To help compare multiple states Savings 529 plans consider using this 529 Plan Comparison by State Tool. This tool is helpful in looking at the specific aspects of each state’s plan. Besides the features of each plan it is a good idea to review the plan’s historical performance. This information will give you a little insight into how the manager has been performing. I also recommend checking out the fine print with a fine-tooth comb. Pay close attention to fees. Is there an enrollment fee? Is there an annual maintenance fee? Do they charge more than a 10% penalty for withdrawing funds for non-educational purposes? Don’t get in a rush here and don’t be afraid to shop around and ask questions to ensure you completely understand.

I’ve picked a Savings 529 Plan…now what?

Once you’ve decided which state’s 529 Plan is best to help you in saving for college, you’ll need to decide how to invest your money. The asset management company that the state has signed up with will be responsible for the day to day investment decisions but you will have to decide which mutual funds best meet your needs. When trying to decide how to allocate you money, base your decision on your child’s age. If your child is eight-years-old or younger consider keeping 60-90% in stocks and the remainder in bonds and cash. Stocks tend to be the riskiest investment option but they often yield the highest return on investment. Since your child is still fairly young, if you lose the money, you have a longer time frame to recover from your losses.

For help in making a decision, check out the Asset Allocation Wizard. If you’re stuck in your decision as to which asset allocation method is best for you, consider age-based portfolios for saving for college. Age-based portfolios are pre-selected stocks and bonds that shift based on your child’s age. When your child is young the portfolio will contain more stocks; however, as your child nears college years the portfolio’s assets will have more bonds which are a more conservative investment option.

Saving for college can be intimidating. After all, we’re talking about your child’s future. However, there are plenty of tools and plans out there to make it as painless as possible. When you’re able to begin saving for college for your child use this article as a helpful reference and remember don’t be afraid to ask your asset management company or adviser questions. They are there to help.

If you have questions about saving for college, please post them in the comments!

Thanks, CollegeSavings.Org, CNN Money, and How Stuff Works!

I am not acting as a financial professional.  The information provided should not be considered personal or professional investment advice; these are merely my opinions.  You should conduct your own due diligence and/or consult with a licensed professional before making any financial decisions.