We all know that, when it comes to finances, planning early is very important. However, even for the biggest planners among us, preparing for a child’s college education even before they are born may seem to be overkill. However, there is a need to start saving now rather than later for your child’s higher studies. Take a look at some numbers that will tell you why saving ahead for college is so very important and why it warrants planning so early on.
According to research by Collegeboard.com, the change in tuition and fees from the 2018-19 period until 2019-20 period is not very alarming. It stands at an increase of about four percent, which is not too bad, considering. However, look at the bigger picture here, and the long- term figures tell you a very different story. From the period 1989-90 to 2019-20, we have seen a threefold increase in tuition fees when it comes to public four-year course institutions. Look at both public two-year institutions and private not-for-profit four-year institutions, and you will see the costs have doubled.
Apart from tuition and fees, students have other expenses to handle too. According to the Collegboard.com’s Trends in College Pricing report 2019-20, full time students say that the aid they received in 2019-20 (for completing a course in public two year institutes) was adequate to cover tuition/fees but they still had expenses amounting to about $8,600 to be met out of pocket. In 2010-11 they had about $1,000 available on hand towards other expenses, but now this figure stands at a very diminished $400.
A look at the loan status tells you how financially burned students are if they choose to study further. According to Forbes.com, the total student loan debt in the U.S stands at a whopping $1.56 trillion this year so far. That encompasses loans taken by about 45 million students. Student loan debt stands in second place after mortgage debt in terms of sheer magnitude, in a position higher than even credit card debt. The average debt that American students may carry from such loans stands at $32,731. The default rate is 10.8%.
These are all alarming numbers that indicate the same thing – student loans are not an easy thing to get rid of. It can become a life-long financial burden, and that’s not something you want your child to face. But what’s the solution? If you intend for your child to get a good education at a reputed college, then you need to plan. And going by the rising costs of college education, you can see why it is important to plan ahead of time, well in advance, so that you have plenty of time to save enough without putting yourself through the wringer to do it.
Why Start Saving Now?
There are two very good reasons why you should stop thinking and start saving if you are already a parent, or even on the way to becoming one.
Better Risk Protection
The economy is fickle; there is no saying how tides could turn in the coming years. The world’s leading economists haven’t been able to predict market downturns with any accuracy on a consistent basis. If a downturn does occur, your ability to save further is going to be seriously compromised even if your accumulated wealth is in safe enough instruments to weather the storm. The earlier you start saving, the more you save and the less pressure there is on you to build up a college fund. Remember that, while under pressure, you might just be pushed to take more risk that you would normally be willing to, and if you are exposed to risky investments and the economy slumps, you are in some serious trouble.
Also, the best way to make the best returns from investments is to hold them for the long term, and this strategy is vouched for by Warren Buffet himself. When you hold investments for the long term, your risk is lower because the investment has a chance to correct itself after a dip and come back to its original value or better.
Also don’t forget the magic of compounding that turns a small saving into an impressive nest egg if you give it enough time. To allow compounding to do its magic on your savings you need to allow enough time, meaning you have to start early, as early as you possibly can.
Expenses Leave Little Scope for Saving
Your baby is your bundle of joy – no question about that, but there is also no escaping the fact that a child in the house is going to make your monthly expenses shoot up. Of course, you want to give your child the very best in terms of safety, health, and comfort, and that means you can’t compromise a lot on these expenses. As a result, you might have very little extra cash to set aside as savings, especially during the initial years. To make sure that your overall savings potential does not take a hit thanks to this, you should start saving even before your child is born, before the expenses increase.
Getting into the habit of saving early on also makes it easier for you to continue to do so for years on end. You may not save as much in the beginning, but you still know how to manage your finances so that you are setting aside some amount each month.
How to Save for Your Child’s College Now
Now that you know why you should start now to save up for your future children’s college education, it is necessary to learn how you can do that in the most efficient, effective manner. The good news is that you have quite a few handy options designed to make this really easy for you while giving you some nice side benefits at the same time. Of course, you can save in your own way, using your own investment strategies to build a college fund, but these avenues are so ideal that they definitely warrant a closer look.
The 529 Plan
This plan gets its name from the IRS section pertaining to adults saving for their children’s future educational expenses. One of the simplest ways in which you can save for your child’s college education, the 529 plan is as good as it gets. Not only does it give you a safe saving route to adopt, but it also hands you a nice tax saving tool in the process. You open the 529 plan with yourself listed as beneficiary even before your child is born. Once the child has their own social security number, you can just switch beneficiaries and name the child instead of yourself.
A very appealing part about a 529 plan, especially for those who cannot quite discipline themselves to save regularly every month, is that you can set up an automatic credit to fund the plan from your savings account. This way, every month, a fixed amount goes into the 529 before you can spend it.
The 529 plan is also called the qualified tuition program, and the most attractive feature about it is that you get to save money without paying taxes on it. That is, if you use the money later for the approved educational expenses, you don’t pay tax on it at withdrawal time. You might earn tax deductions (at state level) for your contributions too, so check on this when you set up your 529 plan.
There are two ways in which you can set up a 529 plan – the prepaid tuition plan and the education savings plan. With the prepaid tuition plan, you pay at current rate the cost of credits at universities that are part of the plan. Later, by the time your child is old enough to enroll, if the price has escalated, you are not affected by the increase. This is an excellent way to protect yourself against hikes in education costs.
The education savings plan is different in that your contributions keep getting added into an investment account that may distribute your money among safe investment modes, such as mutual funds or ETF portfolios. The advantage with this plan is that you can use these funds to cover many more expenses than the prepaid plan accepts, such as room and board, supplies, computers, and more. Withdrawing for tuition fees for K-12 schools is also allowed up to a certain limit with these plans..
Coverdell Education Savings Accounts
These are brokerage accounts that enable you to invest in a stock, fund, or bond of your choice. The limitation of $2,000 per child per year is a big restriction here though that prevents you from saving more if you come into extra cash, but you can always save the extra in a regular fixed income instrument or in a special college fund bank account. There is also a limitation on who can opt for this account that is based on your income. If your income is under the specified limit, you can contribute to the Coverdell ESA. Tax free growth of the funds and a possible state tax deduction make this account very attractive if you fit into the norms.
As with the 529 plan, the Coverdell ESA is also deemed to be your asset and not your child’s so their chances of getting aid from the federal government for education is unimpaired. Unlike the 529 prepaid option, the Coverdell ESA allows you to use the funds accumulated for any expenses related to the child’s education, be it K-12 tuition fees or educational books.
Pay attention to whether or not the funds are fully utilized in time because they may become taxable if they remain in the account when your child turns 30 years of age.
The Roth IRA is a savings plan that comes with a twin benefit for you. You save for your child’s education with tax free withdrawals because you contribute after tax dollars, but if the funds remain after your child’s educational expenses are met, you can simply leave them there to multiply and use them as your retirement fund. Unlike the Coverdell, you don’t have the risk of the funds becoming taxable when your child reaches a certain age.
The Roth IRA is not technically an educational savings plan, but it works well enough for this purpose. The restriction on withdrawals actually works very well in your favor if you have a tendency to dip into savings frequently. The Roth slaps a penalty on you if you take out funds before age 59 ½. However, if you are using the funds for educational expenses, you can avert the penalty, provided the account has been open for a minimum period of five years at the time of withdrawal. Basically, the only expense that you can pull out funds for is the goal that you are saving towards.
The annual contribution limit may be a hassle if you want to save for both college for your children as well as your retirement using these accounts. The saving potential may be curtailed by the limitations, making it impossible for you to save enough to cover both. However, if you have other savings stacked up alongside, Roth IRAs are still a very good option to explore. One thing to keep in mind is that, with these, the withdrawals count as income, and those might impair the child’s chances of getting aid.
Beginning a College Fund
Saving for college well in advance is the best thing to do to ensure that, when it is time for your child to opt for higher education, finances do not come in the way or restrict their choices. The sooner you start, the more you save, and that means the more choices your child has among the best colleges when they grow up. Saving enough also means that you do not need to take a loan out at a late stage in life when your earning years may be limited. It also means your child does not start life with a huge loan hanging over the head.
The 529 plan is one of the most ideal ways in which you can save, with its flexibility and higher contribution limits. The restrictions on the plan may be avoided by choosing the right variant of the 529 as well. If, for some reason the 529 is not the plan you can choose, consider a Coverdell plan. That is a good choice if you meet the income requirements, and you will not be saving more than the contribution limits allow. To make up for these, the Coverdell ESA does have more flexibility in terms of what you can use the funds for after withdrawal. The Roth IRA is what you need if you are trying to double up your college savings plan with an emergency fund for retirement as well. With contributions from taxed dollars and tax free withdrawals beyond a specific time period, the Roth IRA is good savings option too.