Most parents have ambitions for their child to attend and graduate from college. However, when it comes to financing that education few parents are proactively making plans on how to pay. In fact many parents aren’t make any plans at all. According to a study done by Sallie Mae, just 36% of middle class families and 29% of low-income families are saving for their children’s education. That plays into why student debt is at an all time high of more than $1.3 trillion dollars. Fortunately, there are steps you can take to give your child a chance at graduating with as little student debt as possible.
Before I get into the types of savings plans available I would like to highlight a few tips that I believe are often overlooked when saving for your child’s education. A common misnomer in saving for college is that the thought that the parents have the burden of financing their child’s entire education. This is simply not true, Mark Kaurewitz recommends financing 33% of their education.
This gives them a good start and as they get further into their degree encourage them to finance their own education, either by paying for it themselves or seeking out scholarships. Believe me, it will mean a lot more and they’ll thank you for it later. The second tip is to start saving as soon as possible, ideally at birth if you can. Time is the greatest asset when contributing to the various savings plans available to you.
529 College Savings Plan
For many this will be the best option. Fortunately, 49 states currently offer a total of 92 different 529 College Savings plans. The basic concept behind a 529 is that you put after-tax money into the fund and you can withdraw from it anytime you want as long as it is for educational purposes. As I stated before, each state has different investment options and rules, but generally speaking you are able to contribute significantly more than you would be able to in a Roth IRA, but you can only make changes to the account once a year.
What if my child doesn’t end up going to college? Well in that circumstance you can either transfer the account to another beneficiary or withdraw the funds, however the latter will involve penalties.
Roth IRA
This plan is familiar to many as it is one of the most popular retirement plans available, however it can also be used for educational purposes. The way it works, in relation to education, is you contribute after tax money and any gains on the account can be taken out tax and penalty free after five years. There are some limitations though, single taxpayers making more than $129,000 a year ($191,000 for couples) are ineligible and contributions are capped at $5500 per year.
In the event that your child doesn’t attend college you can always roll it into retirement or a down payment on a house.
UGMA and UTMA Custodial Accounts
These types of accounts are used as financial gifts to minors. They contain fewer benefits than a 529 College Savings Plan and are considered your child’s asset so at the age of 18, or 21 depending on the account, they can use it for anything they want. Because it is considered your child’s asset it will count against them if they try and qualify for financial aid. For every dollar over $3000, 20 cents of funding is taken away.
Prepaid College Tuition Plans
With this account, you buy into a participating school’s current tuition rate and when your child goes to school you’re money is locked in at that right. For example, if you buy a prepaid plan at a tuition rate of $8,000 per year and pay $2000, a quarter of the tuition, when your child goes to school it will be worth 25% of a full years tuition, whatever that may be. Basically it protects you against rising tuition rates, which seem to be going up exponentially these days. These plans are usually tax exempt and are offered in 11 states currently with 11 others not accepting new plans.
Coverdell Education Savings Account
This account is very similar to a 529 accounts. It differs in the sense that you can use it for private K-12 education. It’s also a bit more limited in what you can contribute which is only $2000 per year, per child. There are also eligibility limits on single parents making more than $95000 and couples earning more than $190000. Coverdell accounts are considered your asset, so it will have less of an effect on financial aid qualifications than a UGMA or UTMA Custodial Account.
Saving for your child’s education can seem like a daunting task, but it really doesn’t have to be. I recommend starting early, setting up automatic payments so you don’t have to think about setting aside money, and creating realistic financial goals for your particular situation. Again, you don’t have to finance their entire education, encourage them to get a job (college job boards and sites like Craigslist are great for college and high school students looking for work) and apply for scholarships. This will give them a sense of accomplishment and take some of the burden off of you. I hope this guide has helped get you started on the path to saving for your child’s future and if you have any additional questions please let me know in the comments and I will do my best to respond!
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