Last week I looked into when to start saving for college for your child(ren). I shared some financial milestones I thought parents need to be on top of before they sock away college money. Looking at the comments on the post, there were many differing and strong opinions. Some saying that it’s never early to save and others say that parents aren’t under any obligation to pay for their child’s tuition. Please continue share your thoughts on the topic – I think looking at the different perspectives can help shape up your family’s financial plan.
This week I want to tackle how much parents should save for their child’s college fund based on Couple Money reader Becky’s question:
I was wondering if you were going to do a post on how you are preparing for the baby’s future financially (college, etc…) We are expecting in August and are starting to plan for these types of things.
Our biggest worry/concern is starting to act now to plan for college for our child. We really don’t want them to start their adult life with that debt hanging over their head. Any suggestions on that would be awesome.
I’m going to share what I’ve found, but I’d love to get your feedback on how you’re handling your own situation.
Rising Tuitions – Moving Target for Savings
Rising tuition costs have been in the news. Since costs does change drastically from time to time, it makes it much harder to figure out a plan. I searched to see if there was some information on the topic and I did find some hard numbers. I decided if I can use a ballpark figure, it’ll make it much easier to come up with some sort of plan for college savings.
How much does college tuition cost? Without considering the cost of room and board, here are some average tuition costs.
Public four-year colleges charge, on average, $7,020 per year in tuition and fees for students who live in their state. The average surcharge for full-time out-of-state students at these institutions is $11,528.
Private four-year colleges charge, on average, $26,273 per year in tuition and fees.
Public two-year colleges charge, on average, $2,544 per year in tuition and fees.
For estimates later in the post, I’m using the public four year degree fees as part of my estimates. That gives us an estimated total of $28,000. If you want to instead use the private college costs, please adjust the numbers below.
Options for College Savings – 529 Plans and Coverdell Education Savings Account
One decision that you have to decide on is what tax advantaged savings plan you’re going to use. When looking at your options, you should consider the affects of the account(s) on your specific family’s financial circumstances and taxes. The IRS has Publication 970 that cover the topic in detail. Unless otherwise stated, I used it for the reviews below.
A 529 plan, also known as a Qualified Tuition Program (QTP) is a tax-advantaged savings plan. Contributions to 529 plans are not federally tax deductible, but qualified distributions are deductible. States can offer programs that allow parents to prepay tuition or invest their contributions for their children’s educational expenses. For many parents, it’s a better deal to not do the prepaid tuition and instead invest their contributions.
Contributions to a QTP on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary. The beneficiary generally does not have to include in income any of the earnings from a QTP unless the amount distributed is greater than the beneficiary’s qualified higher education expenses.
Most, if not all, States have their own 529 Program, however, you are not forced to use one state over the other. There are some states which choose to provide bonuses upon sign up, or more importantly provide state income tax deductions for 529 c0ntributions.
Luckily, New York is one of those States that provide a State Income Tax Deduction..
If you’re looking into setting up a 529 plan, I suggest reading up some of these great posts:
Another option that some parents prefer is an ESA. The biggest difference I noticed right away was the contribution limit on the account. Here’s a bit more about the account from the IRS:
The total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary is someone who is under age 18 or is a special needs beneficiary.
Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.
There are contribution limits for taxpayers based on the contributor’s Modified Adjusted Gross Income. Contributions to a Coverdell ESA may be made until the due date of the contributor’s return, without extensions.
As tax laws can change year to year, visit the IRS’ site to determine what the MAGI is for the current year.
Decide Which is Right for You
After examining the pros and cons of the 529 plans and Educational Savings Accounts, sit down and decide what’s best for your family.
Your children should also make an effort to pay for their own education through the variety of different methods that are available. After enrolling in any post-secondary institution, have them contact one of the school’s admissions advisers.
Students generally fill out a Free Application for Federal Student Aid form, which is used to determine how much additional capital the student needs to fulfill his or her education goals. This money can come in the form of grants, scholarships, and loans, so the student will have plenty of chances to receive some government money. Every school will have more financial aid information on its website.
These awards are a great way for students to come up with tuition money on their own, which can ease the burden that is placed on their parents. This money also minimizes the amount that students have to borrow to complete their schooling.
Looking at the Time Frame
Now that we have a figure to work with, you have to examine your own personal time frame. Obviously the more years you have between when you start investing/saving and when your child is going to college, the better for your finances.
Let’s say you decided to just save the money and not invest it, here’s how it breaks down on a monthly basis:
18 years -> $129.63/month ($1,555/year)
15 years -> $155.55/month ($1,866.67/year)
10 years -> $233.33/month ($2,800/year)
5 years -> $466.67/month ($5,6000/year)
4 years or less – As much as you can!
A quick mention about investing versus saving- if your time frame is less than 5 years, it would be safer to save that money in a high interest saving and not invest that money.
A Little Perspective
Did you know that the average car loan being around $26,300 ? Looking at it, $28,000 is like a big car loan. If you really want your kid to have their college tuition paid, then dumping your car loan looks like a great way to free up your money for it. I’d also point out that if you get a tax refund, you could sock away some or all of that without hurting your monthly finances.
I just wanted to note that perhaps the reason some are struggling to save is because they have too many obligations with their money. With a little fine tuning you may be surprised at how (relatively) easy it is to save for your child’s college fund.
Thoughts on Saving for College
I would love to get your feedback on this huge concern for many families. How many of you are starting to save for your child’s college fund? How much do you think parents should help with college?