It’s a little nuts to think about saving for college when you’ve just had a baby, yet the beauty of compounding value shows us that starting early is the best way to ensure you can cover as much of the college price tag as possible. Starting to save for college as soon as possible is one of the best ways to ensure your child's future success.
Those that truly plan ahead can open a 529 plan account with themselves as the account owner and beneficiary, then change the beneficiary to the baby after it is born and has a Social Security Number (SSN) or Taxpayer Identification Number (TIN). This will allow them to start saving right away and give their money more time to grow. Additionally, parents can ask for contributions towards their child's college fund at birthday parties or through apps.
The earlier you start saving for college, the more money you will have saved by the time your child needs it. If you start saving at birth, about a third of the savings will come from earnings; if you wait until high school, less than 10% of the savings will come from earnings.
How Much to Save
Saving for university is an important part of preparing for the future. It can be difficult to know how much to save, but there are some general guidelines that can help. The one-third rule suggests that one third of college costs should come from past income (savings), one third from current income and one third from future income (loans). Consider the following figures:
- To reduce student loan debt at graduation, families should aim to save $250-$550 per month for a 4-year college, depending on the type of college.
- Today, the average private university (nonprofit) costs approximately $55,000K per year.
- The average in-state public tuition is $25,000 per year.
- Considering student loan interest and loss of income, the absolute cost of a bachelor’s degree can exceed $500,000.
How Much to Contribute
The amount to save for college depends on factors such as school, degree, and job. Then you have to consider how much you want to contribute. Many people break the costs of college down, and then commit to paying 100% of a subset of costs such as:
- Tuition - that's about 75% of the total cost of sending your child to private school. Tuition accounts for approximately 50% of the cost of public school.
- Room and Board, books, fees - This represents about 25% of the cost of private school vs. 50% of the cost of public.
- The first 2 years of college or 50% of total cost.
Once you identify how much of the college expense you want to cover, you can put the money to work in a savings plan. A 529 plan is a great way to save money and grow the fund without worry. After 15 years, the 529 plan can be rolled over to a Roth IRA account, which provides tax advantages when used for qualified educational expenses.
Pro Tip - There are many online calculators to help you estimate how much you need to save and how much it will grow with investment returns.
What Type of Savings Account Should You Use?
When it comes to saving for college, there are a variety of options available. 529 college savings plans offer favorable tax and financial aid treatment, generous contribution limits, and special estate-planning benefits. Prepaid tuition plans provide a hedge against tuition inflation, but are limited in availability and may suffer from actuarial shortfalls. Savings accounts provide easy access to funds but typically pay interest below inflation, meaning money is losing purchasing power over time. As such, savings accounts are not ideal for college savings due to their low interest rate. High-yield savings or checking accounts, however, are an appropriate place to park your cash before you deploy money in an investment vehicle (e.g., 529 Plan)
Put money away consistently, no matter how much
Starting early and investing the money can help it grow over time, making a bigger impact when they are ready to attend college. Every. Dollar. Counts.
Make Saving Automatic
Saving for college can be a daunting task, but it doesn’t have to be. Making saving automatic is one of the best ways to ensure that you are able to save enough money for your child’s college education.
- Step 1: Reserve money in your budget and accounts to ensure that you have the funds to put into your 529 account. Brownie points if you automate this process and send a percent of your income straight into a protected interest earning account.
- Step 2: Hold your cash in a high-yield savings or checking account so that your money earns interest before you deploy it into an investment vehicle.
- Step 3: Third, set up an automatic transfer from your bank account to your 529 plan account. You can increase the amount you save whenever you get a salary increase or when your child no longer needs diapers or daycare.
- Step 4: Sweep any extra cash. Contributing all or part of bonuses, income tax refunds, and inheritances is another great way to save more money for college. You can even ask friends and family to give the gift of college instead of traditional presents.
529 savings plans are a great way to save for college expenses. They offer federal and some state tax benefits when funds are used for qualified education expenses, and the maximum investments can exceed $500,000 over the life of the account. 529 plans also receive favorable financial aid treatment with no need to report on FAFSA when funds are withdrawn for college. Furthermore, 529 plans offer tax breaks and options to grow savings for college, but earnings are subject to income tax and a 10% penalty if not spent on qualified education expenses.
Investment strategies in 529 plans are limited to what's offered by the program, so it is important to look for a "flexible" 529 Plan that allows you to choose the funds you invest in through the account. Additionally, 529 Plans can be used for other education expenses like K-12 tuition, vocational school or required college textbooks and may offer the option to move funds from one family member to another.
HM Bradley, Inc. (HMBradley) is a financial technology company, not a bank. The information above is for informational purposes only and is not legal, financial, or tax advice, and it may not be suitable for your individual needs; speak to a licensed financial advisor who can help you tailor a plan for your specific needs and a tax advisor who can help you with any tax implications.