How to Save for Kid’s College
Perhaps the most important point to keep in mind when trying to decide how much to save for your kid’s college education and which type of college savings account to use is to just get started. A lot of times we suffer from analysis paralysis, and that keeps us from doing anything at all. This article should give you the information you need to start investing with confidence, but even if you still have questions, just start investing something today. (And ask your question(s) in the comments below. J) That will get you moving in the right direction, and you can fine tune the process as you go.
My husband and I were able to graduate without student loans by following many of the recommendations outlined below, and we didn’t even have college 529 savings plans or education savings accounts available to us. So if you follow the suggestions outlined below and begin saving for your kids’ college when they’re young, you’ll be that much farther ahead! )
1. Start saving for your kids’ college expenses when they’re young.
As is the case for virtually all financial goals that you are trying to save or invest for, the sooner you begin, the better. Because saving for kids’ college should (ideally) be a long-term goal, where you save for 10 or 15 years or more, the best way to save for your children’s college education is to invest in good stock mutual funds. And the sooner you begin to invest, the longer your money will have to grow. There’s a saying among those in the personal finance field that the best time to start investing was 20 years ago. And the next best time to start investing is today.
If you start putting $100 a month, for example, toward saving for your kids’ college expenses the month after they are born and are able to earn an average 11 percent rate of return until they go to school at age 18 (though you won’t need all of the money when they turn 18, of course), you would have $67,127 available for their college expenses. Isn’t that awesome? And tax-advantaged savings account funds such as educational savings accounts and college 529s (which we’ll talk about in the next section) can be used to pay for tuition, fees, books, computer equipment, internet service, and even room and board.
2. Decide which tool is best to use to save for kids’ college.
In order to take advantage of tax-free growth on the money you save for your children’s college, you can use one of three savings methods: a Coverdell education savings account, a 529 college savings plan, or a Roth IRA.
- Coverdell Education Savings Account. A Coverdell education savings account (or ESA) is a college savings account where you can save a maximum of $2,000 per year per child. The advantage of the ESA is that you have complete control over the funds that you choose to invest in. And with the ESA through a company such as Schwab, you have literally thousands of mutual funds to choose from. Though we started investing in our state’s 529 college savings plan (known to be one of the best in the country) shortly after our children were born, we have now switched to ESAs (through Schwab) for our children because of the greater flexibility (and thus greater potential for better rates of return) that they offer. Schwab offers low fees and has been a great brokerage company for us; it’s where we have our Roth IRA, ESA, and general (taxable) investment accounts.
- The 529 College Savings Plan. If you are able to invest more than $2,000 a year into a college saving plan for each of your children as a way to save for kids’ college, then the 529 plan might be the best option for you, if you want to keep things simple. The 529 college savings plans are administered by various states, but you don’t have to be a resident of the state whose college savings plan you choose to use. So, for example, you could use Utah’s college 529 plan (considered one of the best in the country), even though you live in New York. You can invest up to $14,000 per year without incurring the federal gift tax, or you can contribute a lump sum of $70,000 (or $140,000 for joint contributors), as long as you choose to spread the gift out evenly for the next five years. If you want the greater flexibility offered by an ESA but want to contribute more than $2,000 per year, one option is to put $2,000 in an ESA and then contribute the rest that you intend to invest in a 529 plan.
- Roth IRA. If you are hesitant to invest money (or all of the money) for your children’s college savings in a dedicated education savings account because you’re afraid that they might not use all of the money that you invest in these plans or accounts and you don’t want to pay the 10 percent penalty to use the money if they don’t, then you can choose to invest instead in Roth IRAs for college savings, and the tax advantages are the same as investing in one of the two options mentioned above. However, the obvious disadvantage of this method of saving for college is that if you use the money for college, you won’t have it available to you for your own retirement expenses. But if you know that you will have ample money saved for retirement in other accounts such as 401(k)s or 403b’s, then this could be a good option for you. Or you could choose to save some of the money in an ESA or 529 and some in a Roth IRA, to hedge your bets.
3. Decide how much you intend to contribute to save for your kids’ college.
In order to help you decide how much money to invest for your children’s education, an important factor to consider is how much of their college expenses you intend to cover. Some parents choose to pay 100 percent of their children’s college education, some choose to contribute 50 percent, and some contribute less.
Because we want our children to feel ownership of their education and because we hope that they will take their education more seriously if they feel some of the weight of having to pay for it, we’re intending to pay 50 percent of their college expenses. Or, rather, we’re intending to pay 50 percent toward the cost of tuition and fees for an average-priced public university in our state (though we will likely help some with housing and food and so forth as well). We hope that this will encourage our children to choose their school carefully and not choose the most expensive school in the state (if they do, they might be on their own for tuition :)).
If you can afford to pay for all of your children’s educational expenses and if they have already shown a great work ethic and other character traits you want them to have, then paying all of their college expenses may not be a bad idea. However, if paying all, most, or even half of your children’s college education will put your own financial security or retirement at risk, then you should look at contributing less or increasing your income or assets, or both.
4. Decide which mutual funds to invest in as you save for your kids’ college.
As long as you have a timeframe of at least five years and you have a decent risk tolerance, you should invest in mutual funds when saving for your kids’ college in order to benefit from the greater growth that thee funds historically provide (over bond funds and savings accounts and CDs, for example).
If, on the other hand, your child or children will be entering college in less than five years, then your best bet would be to use a regular savings account (or a money market account) or a CD.
Assuming you have at least five years before you will use the money, however, then choose growth stock mutual funds that have been around for preferably 10 years or more and that have good track records. When deciding which mutual funds to invest in for your children’s ESAs or 529 plans, important factors to consider are the long-term rate of return, the expense ratio, the type of mutual fund (large cap, small cap, mid cap, and international), and the longevity of the current fund manager. If you would like to know how we choose which mutual funds we invest in for our children, and why, fill out the fields below, and I’m happy to share the information with you.
5. Make automatic monthly contributions to your children’s college savings funds.
The best way to ensure that you reach your goal of saving x amount for your kids’ college education is if you make automatic monthly contributions to your children’s ESA or 529 accounts. With the Schwab education savings accounts, this is easy to set up.
Read this article for more information on how to automate your finances in order to save for your children’s college educations, invest for retirement, pay your bills, save for emergencies, and more.
6. Look for ways to increase your income to be able to save more money for your kids’ college educations.
If you want to be able to save more toward your children’s college educations, one of the best solutions might be to work on increasing your income. For more information on how to earn more money, sign up for my free 10-day Earn More Money, Change Your Life challenge so you can start working on increasing your income today!
As is the case with so many things, the sooner you begin to save for your kids’ college, the better. By starting to save early, consistently contributing to a college savings fund, and choosing good mutual funds to invest in, you can help your children to obtain a great college education without any student loans. Please, if you can, please make a commitment to help your children (if they’re willing) to accomplish that goal, however you need to work things out to make that possible. Please help them to avoid student loans so that they won’t have that potentially huge burden when they graduate from college, like a ball and chain that they have to carry with them for 5, 10, 15, or even more years into their career.
Even though saving for our three kids’ college educations since they were a couple of months old has meant that we haven’t had as much money available for other expenses, the tradeoff has been well worth it. Our children may grow up largely in second-hand clothes and with mostly preowned toys and riding in only new-to-us cars, but our goal is that they will never know the stress nor feel the burden of student loans. (Or of any debt at all, for that matter—except for maybe a reasonable mortgage.) Both my husband and I graduated with college degrees without any student loans, and that’s a legacy we intend to pass on to our children.
To learn more on this topic, read this article on how to pay for kids’ college.
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