I’m a decade away from sending my oldest child off to college, but college costs are already on my mind. With college tuition costs at a public 4-year institution exceeding $10,000 a year, sending your child off to college comes with a hefty fee. In my case, I have to multiply those costs by three, which means we’re facing six figures of college tuition expenses. The best way to prepare for these future expenses is to save––and save early.
Follow this guide to devise a college savings plan that works for your family’s budget.
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Set a Realistic Goal With Your Finances in Mind
How much money you can save for college is personal and specific to your family. Budgets vary, and the reality is that you just might not have a lot of extra money at the end of the month to dump into a college savings plan. However, a tight budget doesn’t necessarily mean you can’t be thinking about college costs now.
Even tucking a small amount of money away every month can start building your savings. If you start saving when your baby is born, you have 18 years to build up some savings for college. Keep in mind that your financial situation may change––perhaps even dramatically––in those 18 years, so you might be able to save more aggressively in the future. For now, just focus on devising your college savings plan and setting aside whatever amount of money you can.
Start a Savings Account
First, open a savings account for your child when they are born. Ideally, you’ll open the account at the bank you already work with, which allows for easy transfers into savings. Look at your budget and determine how much money you can set aside for college every month. Whether it’s $50 or $250, whatever money you can put toward college now will make covering growing tuition costs easier in the next decade or two.
If you don’t have a lot of money every month to set aside for college, look at other ways to build this savings account. When your child receives a cash gift from a family member, add it to savings. Over the years, those birthday gifts and holiday gifts will accumulate. If you get a tax refund every year, add some or all of that money to savings. If you receive a bonus annually, consider dedicating a portion of it to college savings. When your child goes off to kindergarten and your childcare expenses go down significantly, apply some of that extra money every month toward college since you’re already used to spending it.
Design Your College Savings Plan
Several college savings plans are available, and these accounts are another way to supplement your savings. Several options are available, so it’s important to understand each type so that you can find the right one for your family’s situation.
A 529 plan is a tax-friendly savings plan that’s designed for educational expenses. States, state agencies, and educational institutions themselves sponsor these plans. All 50 states offer at least one 529 program, with many offering different plans. You’re not limited by geography when selecting a plan. You don’t have to sign up for a plan offered by your state, nor does your child have to attend college in the state where you have a plan. You can live in California, sign up for a 529 plan in Florida, and have your child attend college in New York. These state-sponsored plans can be used nationwide at more than 6,000 colleges and universities, so they give your child plenty of flexibility when selecting a school.
529 plans are tax-advantaged investment accounts, which means that these savings accounts can grow without being subject to federal taxes when you use them on qualified expenses like education. Some also feature low fees, so you don’t have to worry about paying significant maintenance fees to keep the account open. Since you can open a 529 in any state, it’s smart to shop around to find one that offers low fees and a balance minimum that suits your budget.
529 plans are popular options for college savings. The earlier you invest in them, the longer you have to let your earnings grow. When you set it up, you’ll choose from different investment options to maximize your earning potential. Then, when you send your child off to college, you can make withdrawals to cover a variety of college expenses. In addition to covering tuition costs, 529 savings can also be used on room and board and other fees.
This plan works well for high earners or any individuals who want to invest large sums into the account. There isn’t an income limit, and the plan has higher contribution limits than other college savings plans. While contribution limits depend on your specific plan, many plans allow you to deposit tens of thousands of dollars annually with a total lifetime contribution limit in the hundreds of thousands of dollars.
Coverdell Education Savings Account
A Coverdell education savings account (ESA) is another way to make cash contributions toward your child’s college tuition. While a Coverdell ESA is similar to a 529 in some ways, its main difference is that these accounts limit how much you can contribute annually. They permit a contribution of a couple thousands dollars per year. This account can have multiple contributors, which means both parents and even grandparents can contribute to the account, so long as the total does not exceed the maximum annual contribution.
Coverdell ESAs also have income restrictions. So, if you have an adjusted gross income of more than $110,000 (or $220,000 for a married couple), you won’t be able to open an account. A 529 will be better suited for your family. However, if you do qualify and want to set aside a modest amount each year, consider a Coverdell ESA.
UGMA and UTMA Accounts
UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) accounts are two other college savings options. These custodial accounts offer an opportunity to set aside funds for your child’s tuition in a separate savings account. In addition to cash deposits, these accounts typically also allow stock, bond or mutual fund deposits. However, any high-risk investments aren’t usually allowed. These accounts have no contribution or income limits. However, the more you add to the accounts, the more tax they’re subject to. Small contributions aren’t taxed and are then taxed at the child’s rate. However, as your contributions accumulate, the rest of the money will be taxed at the parents’ tax rate.
Explore Prepaid Tuition Options
Prepaid college tuition plans are another savings option, but they’re less flexible in how your child can use the money. Prepaid tuition plans allow you to lock in current tuition rates for your child. So, if you had a baby last year and signed up, you would be locking in the tuition rates from your child’s birth year, even though your child won’t start college for another 18 years or so.
While that sounds like a smart financial move (and it can be), there’s a catch. You commit to this prepaid tuition plan in a specific state, which means that your child has to attend one of the state colleges and universities that are included as a part of the program. So, you’re limiting your child’s college options by choosing this plan. However, you’re not dictating exactly where your child attends college. In your chosen state, most, if not all, public institutions accept these funds, which means your child will have some choices, albeit fewer.
While prepaid tuition plans were once quite popular, fewer states are offering them. So, when evaluating this type of college savings plan, determine whether the available states are right for your family. For example, if your home state offers a plan, it might be a smart choice since many kids stay in state for college. However, choosing a state across the country might be a risky move in case you have a child who wants to stay closer to home for college.
The Bottom Line
Saving for college might seem like a daunting task, but it doesn’t have to be. A variety of savings plans are available, from your basic savings account to investment accounts like 529s and Coverdell CSAs. When you’re determining which type of savings account is right for you, ask yourself these questions:
- How much money can I invest every year?
- Does my income limit what types of accounts I can open?
- Do I want to use the savings on tuition alone or other expenses like room and board?
- Do I want my child to attend college in a specific state?
Your answers to these questions can help guide you as you select the right savings path for your family. Consider mixing and matching options to suit your needs. For example, you might only have the funds to start a small savings account when your child is first born. Use it as a way to tuck away cash gifts or modest recurring deposits. As your financial situation evolves, you may consider opening up a 529 account to supplement your initial college savings. Jump on those investment accounts as soon as you can commit to them because you want to give your money time to appreciate.
High school graduation might seem like a lifetime away, but it’ll be here faster than you can ever imagine (cue the tears!). Watching your savings account grow throughout childhood can build your confidence as you approach college, which just might be the costliest part of your parenthood.