For many parents, college is a major milestone in your child’s future. A college education can set your child on the path to a rewarding career, both personally and financially. The college experience can also leave them with memories and friendships that last a lifetime. However, post-secondary education carries a hefty price tag. If you’re wondering how much to save for your child’s college fund, you’re not alone. In this blog post, we’ll discuss how much to save for college, plus some tips for starting a college fund.
Do you need a financial plan that will serve your family today and in the future? We’re here to help. Schedule a call with Bay Point Wealth today.
How Much To Save For Your Child’s College Fund
Saving for your child’s education is a smart move for several reasons. It helps ensure you can provide your child with the flexibility to attend the college of their choice (and stay in their good books). Starting a college fund also prevents you from getting hit with all the costs at one time. Finally, it allows you to take advantage of tax savings opportunities—and who couldn’t use some extra cash at tax time?
So, the big question is, how much should you save?
The Cost Of A College Education
Before you can figure out exactly how much to save for college, it’s important to understand the cost of this investment in your child’s future.
The average yearly cost to attend college in America today is $35,720, according to the Education Data Initiative. However, the cost can vary from $53,949 per year if your child attends a private college to $25,615 if they attend an in-state public college. Costs are also rising by nearly 7% every year and have tripled in the past two decades (sorry to be the bearers of bad news!).
How Much To Save For College
Depending on how many children you have and your family’s financial situation, the best saving plan for your child may look different than someone else’s plan.
You first need to decide how much of their education you want to fund. Some parents choose to fully fund their child’s education no matter what, while others fund it up to a point—but not at the expense of sacrificing their own retirement dreams.
When making your decision about how much to save for college, consider how much choice in schools you’d like your child to have and whether you want them to avoid graduating with any debt. This is a personal decision that only your family can make.
Let’s say your goal is to save enough to pay for a four-year in-state education with a cost of $28,000 in today’s dollars. If you assume that expense will increase by 6% per year, the total cost of the four-year education would be approximately $370,000 in 18 years. If you assume you’ll invest your funds in a 529 plan (more on that later), which will earn 8% per year, you would need to save approximately $580 per month or invest a lump sum of approximately $77,000 in today’s dollars.
Pro Tip: One universal piece of advice when it comes to starting a college fund is to begin putting money away as soon as your child is born. When saving for a large expense like college or retirement, it’s hard to play catch-up. The longer timeframe you give yourself to save, the more your compounding earnings will work for you to help you reach your objective. You may even be able to put away less money over time.
Creating The Best Saving Plan For Your Child
Once you figure out how much to save for your child’s college education, it’s time to make a plan to put the money away. Let’s explore a few different options.
Best Savings Option: 529 Plan
If you have the ability to start a college fund separate from your family’s other savings accounts, a 529 plan is an ideal choice. This is a state-run plan, and each state has its own version. You may be able to take advantage of tax benefits by using your state’s 529 plan.
For example, if you live in Maryland, you can receive a $2,500 state tax deduction each year for the contributions you make to your 529 plan. The good news is that if you and your spouse make joint contributions, you can get a $5,000 deduction. The even better news is that you can carry forward those deductions for 10 years. This means you can frontload your contributions and put $50,000 into the plan at one time, then take a $5,000 tax deduction each year for 10 years.
Types Of 529 Plans
There are two kinds of 529 plans to consider:
- The first option is a 529 Investment Plan, which allows you to invest your money in the market. The value of your account is based on the money’s growth.
- The second option is a 529 Prepaid Plan, which does not come with any investment risk. However, this kind of plan is limited to the cost of an in-state education, and it may be harder to determine the value if the funds are not used for education. With this option, you pre-pay the cost of tuition in your state upfront in today’s dollars, and the plan will cover the cost of the in-state public tuition, no matter how much it costs.
Advantages Of 529 Plans
One benefit to using a 529 plan is that it gives your money the opportunity to grow tax-free. This means your earnings are not taxed when you pull the money out, as long as you use the funds for qualified education expenses. Or, if your child throws you a curveball and decides not to go to college, you can change the beneficiary to another child or someone else, or withdraw the money and pay tax plus a 10% penalty on the earnings.
Another benefit is that funds contributed to these accounts are not considered as part of your estate if you pass away. However, you still have control of the assets in the event the beneficiary does not go to college or you happen to need the money for yourself. You can front-load a 529 plan with five years of gift tax exclusions, meaning you could add $75,000 to the plan without having to report the gift on a tax return or reducing your overall estate tax exemption.
Finally, in addition to paying for college expenses, you can use the funds in a 529 plan to pay $10,000 per year for K-12 tuition if you decide to send your child to a private school.
How Your Money Goes Further In A 529 Plan
If you contribute $10,000 and it grows to $100,000, you don’t have to pay tax on that money if you use it for qualified education expenses. Alternatively, if you contributed $10,000 to a regular brokerage account and it grew to $100,000, you’d have to pay capital gains tax on it when withdrawn and you’d only end up with approximately $80,000 left.
Other Savings Accounts
Education Savings Accounts
With an Education Savings Account, you can invest $2,000 per year, which will grow tax-free if used for elementary, secondary, and higher education expenses. These accounts have specific eligibility and contribution restrictions, which limit the benefits to using them and have made them less popular than the 529 option.
You can exclude from your gross income all or part of the interest you pay when you redeem eligible savings bonds, as long as you’re using them for qualified higher education expenses at an eligible institution.
If you’re unsure whether your child will go to college, whether you want to pay for their education, or how much you want to contribute, you can hold savings in a regular taxable brokerage account. Remember that you won’t gain the benefit of tax-free growth with this option. As well, having a large amount of funds in a non-qualified account may affect your ability to receive financial aid.
Yet another avenue to explore is funding a Roth IRA. You can always withdraw your contributions to these accounts without penalty or tax if the account has been open for five years. You can also avoid the 10% penalty on earnings if you take a withdrawal and use the funds to pay for qualified higher education expenses.
401(k) or IRA
Finally, those who would like to put retirement first can max out your contributions to your 401(k) account, then take a loan from the account to pay for your child’s college education. Or, if you contribute to an IRA, you can avoid the 10% withdrawal penalty if you use the funds for higher education expenses. If you’re in a high tax bracket or need to put your own retirement savings first, this could be a good choice for you.
What To Consider When Saving For College
We’ve covered a lot of ground so far. Now, here are a few simple tips to keep in mind when starting a college fund.
Call In The Pros
Working with a financial advisor can help ease the overwhelming prospect of saving for your child’s education. An advisor’s goal should be to help you achieve your objectives, so they’ll start by encouraging you to decide whether paying for college in full or funding your retirement is your top priority. Once you’ve determined your main financial objective, you can make a plan that works for your family.
Keep in mind that there is no way to fund your retirement with loans, so you should try to save as much money for retirement as possible. Then, try to pick the best place to invest your money so you can maximize your wealth to help pay for college or fund it entirely. A financial advisor can walk you through all the possible routes to take.
More Key Tips
Ready for the rapid-fire round? Take notes on these tips for creating the best saving plan for your child:
- Make a monthly contribution to the savings account.
- Save enough to cover rising costs by the time your child is 17 or 18.
- Use the right vehicle to save (likely a 529 plan).
- Consider your and your child’s potential for financial aid or a scholarship.
A Compassionate Perspective
At Bay Point Wealth, our team understands the importance of family. We’re dedicated to creating the right financial plan for you to help you achieve your goals and secure your family’s financial future. Saving for college is one piece of the puzzle—but we consider everything from a big picture point of view to ensure your entire plan fits together seamlessly. Interested in learning more about our approach? Schedule a call with us today.