5 Things Parents Should Know About Saving for College

Parents should start early, create a budget and look at investment vehicles to save for higher education.

by Hudson Lindenberger

One of the most important choices that a parent will face is how they’ll fund your kid’s college education. And it’s important to note that that choice needs to be made much sooner than many might assume. “We are entering a time when having a college degree very well might be the most important indicator of future success for your child,” explains Carol Stack the co-author of The Financial Aid Handbook: Getting the Education You Want for the Price You Can Afford. She notes it can be a daunting to get a handle on costs that quite possibly are a few decades in the future. Still, it all begins with a few steps, and once the process is started everything seems to get easier.

Start Now.

If there is one certainty about college, it is that it will not be free. In fact, since the mid 1980’s the cost of sending a child to university has continually grown every year. Just this century alone the average cost of education, plus room and board, at four-year public, and private colleges has risen 64 percent and 37 percent respectively.

“If you have a child of any age you should be saving money for the college education right now,” says Stack. “Even a few dollars a day can make a huge difference.”

It’s the power of compound interest that makes it so vitally important to begin saving as soon as possible. As the money saved earns a return, the cash earned on interest also earns a return. It can add up quickly. If parents invested just $1,000 a year at a 7.5 percent assumed rate of growth, it would add up to $42,000 by a child’s nineteenth birthday.

College is a major expense and one that requires careful planning. “When you build your household budget college savings needs to be a part of it,” says Stack. “Once you know how much you want to save each month then you need to figure out where to find it.”

Create a Budget

Some suggestions that Stack has include cutting out the daily Starbucks run; instead, parents can make coffee at home. The $3.00 saved each day adds up to $780 at the end of the year. Another idea is to build vacations around college visits when kids children get older. Parents can also ask family members to gift money into a college fund instead of buying children a bunch of toys.

“As my kids grew up we never bought new cars, instead we would take the savings from driving our current cars and roll that into their college funds,” says Stack.

Learn About the 529 Plan

There are a variety of ways to save money for college. Parents can open a bank account, create a trust, or stuff into the mattress, but the most popular way is to open a 529 Plan. “Approximately 80 percent of all dedicated college saving plans are some form of a 529 Plan,” says Brian Roberts CFA and Principal Partner at Nelson Roberts Investment Advisors. “They are a great tool that enables money to grow tax-free, and distributions for qualified post-secondary education are free of tax.”

Every single state offers some form of a 529 Plan that is specifically designed to encourage saving for future college costs. The money saved in them is able to be used for “qualified higher education costs” according to the Securities Exchange Commission. That means the monies saved can go towards tuition, mandatory fees, room & board, books, and computers.

Another positive is that there’s no age limit for dispersal of the funds, no residency requirements about where the money is spent, and many plans allow investments in excess of $200,000. But parents should be warned that plans vary by state with some offering better tax incentives than others. Contacting a professional to find out the best plan, is key.

Know your Savings Plan

When parents decide to save money for a child’s future the need to make sure they know exactly what their plan offers. Many plans have contribution limits of $14,000 per child, per parent, per year under the Annual Gift Tax Exclusion. Plus the tax implications vary from state to state.

Some states still offer prepaid tuition plans that allow the purchase of credits at schools to be used for future tuition. They are a great way to save for school but the pool of states offering them is shrinking, as is the state governments guarantee of the investment.

If parents decide to open a custodial account under their child’s name for school, they need to understand that once a kid comes of age the funds don’t have to be used for school. The cash is theirs and they have unfettered access at some point between age 18 to 25.

There are education saving accounts that can be used for high school or private elementary schools. A Coverdell Education Savings Account (ESA) can be used on a greater latitude of education costs, but have stricter contribution limits and income qualifications.

Study the 529 Plan.

Similar to any pool of savings, careful consideration should be given to the time horizon, options, asset allocations, investment vehicles, and costs of the investments chosen within a 529 Plan.

Most 529 plans have a structure like a 401k with a menu selection of mutual funds or Exchange Traded Funds that vary in style and cost. Investors are able to decide where the money is invested throughout the lifetime of the plan.

“Education is an important savings objective and you need to do your homework about where, and what, the investments are doing,” says Roberts.

Roberts pays particularly close attention to the State sponsored plans’ administrative fees and the expense ratios within the menu selection of investment vehicles for the clients of his firm. “Being mindful of the fees associated with the investment selections enables the maximum amount of dollars to accrue toward the benefit of the beneficiary’s education”.