Sponsored By: A+FCU

Saving for College

austin-moms-blog-saving-for-college

Have you started saving for college? While it’s never too late to start, it’s usually better to start early to get the full advantage of compound interest.

But where should you start? What are your options? How much should you save? All these questions can be confusing and may lead to decision paralysis instead of saving.

Should I save?

The first question you should ask is whether or not you can afford to save for your child’s education. But being able to afford it doesn’t just mean that you have the extra money in the budget. You need to make sure you’re meeting your other financial priorities first.

Many financial experts argue that while saving for a child’s education is important, it shouldn’t take priority over saving for retirement, building your emergency fund, and paying down high interest credit card debt.

Once you have these bases covered, then you can start looking at how much you can afford to set aside for your child’s education.

How much should I save?

College costs are always projected to rise, usually anywhere between 3-7% per year. Taking a look into the future and using a College Costs Projector Calculator, here are some numbers to get you thinking.

The numbers below project the total cost of college for a child depending on their age and a 5% tuition inflation rate.

Notes: the current costs were taken from College Board ® Trends in College Pricing report for the 2014-2015 school year and include published tuition, fees, room and board.

collegecostsAMB

 

While those numbers can look intimidating, remember that a lot can happen in 8-17 years, especially with the cost of college being a popular topic in politics and in the news. These numbers are merely to give you something to aim for.

Some experts suggest parents aim to save at least one-third of the projected costs and that the remaining two thirds come from child savings, grants, scholarships and student borrowing.

The hard part is determining how much to save per month or per paycheck. A lot needs to be taken into consideration, especially expected return over the years. Investments can’t always promise a consistent return which makes it difficult to plan. But using savings calculators can give you a place to start. Let’s take a look at a 5-year-old child planning to attend a 4-year public university.

If you aim to save one-third of the approximate cost, you’d need $51,319. You have 13 years to save. Assume a 5% rate of return with monthly compounding and a $100 initial deposit.

To reach your goal, you’d need to save $233.34 monthly or $53.70 weekly or $7.67 daily.

Remember, this is just a starting point. You may not be able to save that amount every month. Choose the amount that works best for you and your budget.

When should I start?

Ideally, you should begin saving as soon as possible. Compound interest works best over a long period of time. For example, look at these two scenarios:

  • Scenario #1: you save $200 a month as soon as your child is born until he or she turns 18 (18 total years) in an account earning 5% interest ($43,200 invested). At 18, you would have saved $70,131 ($26,931 interest).
  • Scenario #2: you save $900 a month when your child turns 14 until he or she turns 18 (4 total years) in an account earning 5% interest ($43,200). At 18, you would have saved $47,912 ($4,712 interest).

In both scenarios, you saved the same amount, but there’s a big difference in how much interest you’ve earned. So the sooner you begin saving, even if it’s a small amount now, the better off you could potentially be.

What are my options?

One of the most important decisions you need to make is the type of account you use to save your money. There are a lot of options out there and each has its pros and cons. You need to choose the one that best fits your needs. We recommend talking with a financial advisor to pick the best option.

  • Savings Accounts and Certificates of Deposit. These types of accounts can be used to set aside money for college, but don’t typically pay high rates of interest.
  • Savings Bonds. A savings bond (specifically a Series EE or Series I) can be a great way to save money for school. You buy the bond for a lower price than its worth and over time, the bond’s value increases. When you cash it in, as long as you meet certain IRS requirements, the proceeds come out tax-free. But like savings accounts and certificates of deposit, savings bonds don’t have that high of an interest rate.
  • Coverdell Education Savings Account. A Coverdell ESA, formerly known as an Education IRA, is a type of tax-advantaged account where the contributions are not tax-deductible, but the earnings grow tax-free and disbursements are tax-free as long as they are used for qualified education expenses. Coverdell’s can also be used to save for elementary, secondary and post-secondary educations.
  • 529 College Savings Plan. This type of 529 Plan allows you to contribute money that is then invested in different “plans” usually designed around your child’s age and possible college start date. The money grows tax-free and withdrawals are tax-free as long as they are used for qualified education expenses.
  • 529 Prepaid Tuition Plan. This type of 529 Plan allows you to pre-purchase tuition credits at specific schools. You’re not investing money in a plan, but rather buying tuition credits at today’s prices for a future education.
  • Roth IRA. While not traditionally a college savings tool, you can withdraw from your Roth IRA penalty-free for college expenses. However, earnings will be subject to income tax and withdrawals will count as untaxed income when filling out the FAFSA for the next year. This could impact the amount of financial aid your child qualifies for in the future.
  • 401(k) Loan. Taking a loan from your 401(k) is another non-traditional source for college money, and typically not a great option. You may reduce your potential earnings, your payments are made after-tax unlike your contributions, and if for any reason you leave your job while you’re paying the loan back, the balance is due immediately.

As with any big financial decision, it’s important to be informed and ask questions. Got questions? Email us at [email protected].

Learn more about raising money smart kids at aplusfcu.org.

Please note: none of this should be considered tax or investing advice. Please talk with a tax or financial advisor for your specific questions.

LEAVE A REPLY

Please enter your comment!
Please enter your name here