How can I possibly save enough for my child’s college education?

While it’s true that saving for college is easier the earlier you start, all hope is not lost if you waited a few years to get started. Despite the rising cost of a four-year degree, it’s still an important asset for climbing the career ladder in most professional settings.

Paying for college is a financial goal for many parents but with an 18-year savings timeframe, it can easily fall by the wayside. Many people get so wrapped up in the day-to-day realities of getting the bills paid that they don’t get serious about college savings until their children’s preteen or teen years.

The best advice when it comes to saving for college is to start saving as soon as possible. The sooner you start, the more time the money has to compound and grow.

If you haven’t started saving yet, now is the best time to open an account and add money to it. Pushing off saving for college to a future date only means your child will incur more student loan debt.

Planning to pull out money from your retirement account to pay for college isn’t a great saving strategy. Don’t use your retirement funds to pay for your child’s higher education expenses. If you drain your retirement funds, you can’t borrow money or get a scholarship for retirement.

Your kids can pursue other ways to pay for school such as financial aid and student loans. Don’t make the mistake of jeopardizing your retirement by raiding your nest egg.

How to determine college costs

When it comes to estimating higher education costs for your child, the numbers can vary greatly depending on your personal priorities. According to College Board, a four-year degree has an average annual price tag of $21,370 for tuition, fees, room, and board. If you’re looking to go private, that figure more than doubles to $48,510.

These numbers are for the 2018-2019 school year with an average annual year over year increase of 2.8 percent for public and 3.2 percent for private. That’s not a small change. If you have not started saving for college yet, now is the time to make a plan for the future.

First, decide if you plan to pay for a public or private school so you have a better idea of the cost of a four-year degree. This will give you a rough ballpark number in today’s dollars that you can use for your saving predictions and planning.

To determine the amount you need to contribute monthly, divide the projected amount by the number of months remaining until your child heads off to school. This is the number you need to incorporate into your monthly budget.

Formulate a plan

One of the most important parts of paying for your child’s higher education is formulating a plan. This will keep you on track and ensure you meet your savings goals. In addition, it’ll give you the chance to come up with different options for paying for college. As soon as your kids are old enough, take this as an opportunity to involve them in the process.

If you’re not sure where you start, talk to a qualified financial planner who can help you put together a plan that works with your finances. A financial planner can look at the full financial picture for your family and make appropriate recommendations that will fit your goals and your budget.

How much should you save for college?

When you first add up the cost of higher education for your child, the number can seem overwhelming. Don’t let this discourage you.

Remember, having some money saved, even if it doesn’t fully cover a four-year degree, is always better than nothing. Every dollar you save today is money your child wouldn’t have to borrow and repay down the road.

The best you can do with determining how much to save is to get a ballpark estimate of the current cost of a public and private education. Decide which one you would like to save for and make a plan based on how much it would cost today to send your child to a four-year public or private college.

When should you start saving for college?

In an ideal world, you should have started saving for college when your child was born. However, we all know life can get in the way so this doesn’t always happen.

If you haven’t started saving for your child’s college education yet, the best time to get started is today. Don’t put this off any longer - you’ll only regret it in the end.

Options for saving for your child’s college education

There are several different options when it comes to stashing money away to cover higher education costs. Some give you more flexibility but often at the expense of future earnings. Others are more limiting but give you the best chance for future growth and higher returns.

Saving account or CD

One option for saving for your child’s college education includes stashing some cash in a savings account or a certificate of deposit, known as a CD. According to Sallie Mae, 22 percent of parents use savings accounts to put away money for future higher education costs. Making this a habit helps parents save more with six in 10 making regular deposits to the college fund.

While these types of accounts are considered safe, they do have the drawback of low interest rates. You’ll get much better returns investing the same amount of money in a 529 plan, depending on market conditions.

Additionally, be careful how you classify the funds in the account. Students’ income and savings have a bigger, more negative impact on the availability of financial aid than parental assets and income.

If you want to reach your savings goal, you will more than likely have to take on more risk investing your money than simply putting it in a safe, low-interest account. Currently, the best CD yields hover around 3 percent for a five-year CD while the S&P 500 has returned an average of 11.32 percent over the last five years, according to Morningstar (as of 11/2018).

529 Plans

Saving for college in a 529 account is similar to putting money away in a Roth IRA. It’s a tax-advantaged account that helps you save for your child’s higher education expenses tax-free through several options. These accounts offer significant tax advantages by allowing any gains on the account to be tax-deferred,

When you withdraw the funds to pay for qualified expenses, you will not pay any taxes as long as they are used for qualifying expenses. Additionally, you pay no federal taxes on your account's earnings, and there may be state tax benefits as well.

The money inside of a 529 college savings plan can be invested into diversified, low-cost stock and bond funds. Some offer age-based investment packages, which work like a target-date fund in your 401(k).

With those types of funds, the contributions are placed in stock-heavy investments when the child is young and automatically reallocated to a higher percentage of bonds and cash as the child nears college age.

Money in a 529 account can be used to pay for undergraduate or graduate degree at an accredited two- or four-year institution in the U.S. However, in addition to riding out the stock market ups and downs, you’ll need to consider the possibility of your child not attending college.

In those cases, you can change the beneficiary but the funds must be used for education expenses such as room, board, tuition, books, fees, and supplies in order to receive them penalty and tax-free.

Withdrawing the funds to use them for a purpose other than to pay for education costs will mean getting hit with a penalty similar to an early withdrawal from your 401(k). Funds spent on unqualified expenses will incur a 10 percent penalty on earnings in addition to income tax.

Even with these restrictions, this is the most popular type of college savings vehicle with 30 percent of parents using it to stash away money.

Coverdell ESA plans

The other major type of college savings account is a Coverdell ESA plan. It has a lower annual contribution limit of $2,000 per beneficiary but the money can be invested in a wide variety of stocks, bonds, or funds, similar to a 529 plan. If you use the funds for qualifying education expenses, all withdrawals of investment growth will be tax-free.

Keep in mind that contributions are made after taxes, which means that you don’t get a tax deduction for the money you stash away. However, any investment profits and contribution withdrawals are tax-free when used on qualifying expenses.

Another important consideration is that Coverdell ESA contribution eligibility phases out for individuals with modified adjusted gross income (MAGI) above $95,000 annually and completely disappears for MAGI above $110,000. Those limits for married couples filing jointly double to $190,000 and $220,000 respectively.  

Money in a Coverdell ESA must be used for qualified education expenses, including tuition, fees, books, supplies, room and board, and computer and related equipment if used for school. Additionally, funds can be used for certain elementary and secondary educational expenses (but as of 2018, a 529 can be used to pay for these expenses as well).

In the case of your child not needing the money, the funds are transferable to another beneficiary, such as another child. If you decide to take out the money, you’d incur taxes and penalties so this should be a last resort.

Prepaid tuition plans

If you think that your child will likely attend an in-state public school, you may want to check out prepaid tuition plans. These are not offered by all states so check to see if yours has this option. The plan will allow you to pay for tuition credits at a predetermined price and offers the same tax advantages as a 529 plan.  

The biggest drawback of these types of plans is that if the child decides to go to school out of state, you won’t get the full value of the plan. In addition, it’s a challenge for states to keep up with the growing costs of college.

You can change the beneficiary of the plan just like with 529 and Coverdell ESA plans but the money can only be used for tuition. Using the funds for other expenses will net you a 10 percent penalty.

Roth IRA savings

Another savings vehicle that is not often discussed in articles about stashing away money for college is a Roth IRA. You can give your children a financial head start by opening a Roth IRA in their name once they begin to earn income.

When they turn 18, they will get to control the account but the restrictions and penalties for early withdrawals should help minimize taking out the funds prematurely.

You can make penalty-free withdrawals from a Roth IRA for specific types of spending such as for qualified education expenses or for purchasing a first home. However, if you decide to use a Roth IRA as part of your savings strategy, it’s important to consult with a qualified financial planner as there are some caveats about what assets count toward your child’s financial aid application.

UGMA/UTMA account

If you think that there’s a chance that your child may decide against going to college, you can open an UGMA or a UTMA account and still reap some tax benefits. UGMA stands for Uniform Gifts to Minors Act and UTMA stands for Uniform Transfer the Minors Act.

Basically, these types of accounts enable you to make a financial gift to a minor and name someone as the custodian of the account. The first $1,000 in gains is tax-free, the second $1,000 is taxed at the child’s income tax rate, which would presumably be lower than yours. The remainder is taxed at the parent’s income tax rate.

The advantage of this type of account is that the money can be used for any purpose that directly benefits the child, even if he or she does not go to college. The bad news is that once your child reaches the age of majority (18 or 21 depending on the state), you can’t legally control how the money is used - whether it’s for a house down payment or a sports car.

If your child decides to go to college and wants to apply for federal financial aid, a custodial account is regarded as an asset for your child and will be counted against them when they fill out their asset statement for the financial aid application. This is why it’s important to consult with a qualified financial planner when mapping out your college savings strategy.

Consider an alternate plan

Even if you have only a short amount of time to save before your child goes to college, don’t despair. First, review your budget and figure out how you can start setting aside as much as possible for your child’s college education.

Talk to your child about college and get an idea of what schools they are considering so you can review the costs and make a plan. Involve them in the process and ask them to help you brainstorm ways to make college more affordable.

Make a plan for how you’re going to cover college costs and consider alternate plans. One option is to have your child attend a community college for two years then attend the last two years at a college or a university.

You can also work with your child on finding and applying for scholarships to help offset some of the costs. Even a $500/year scholarship can cover the cost of college textbooks.

If you think you can qualify for some financial aid, it’s important to minimize all assets in your name and your child’s name that would be counted against you. Talking with a trusted financial planner can help you optimize your college savings and make a plan that works with your financial situation.

Getting ready to apply for FAFSA. Check out this great guide to FAFSA for parents.

This is a post from Clint Haynes, a Certified Financial Planner® and Financial Advisor in Kansas City, Missouri. He is also the founder and owner of NextGen Wealth. You can learn more about Clint at the website NextGen Wealth.