Saving for College

College planning can be a stressful and confusing process and is particularly overwhelming for those who start—or think they start—too late. But one thing is certain: you will be significantly better off if you start planning and saving now, no matter how old your child is.

Even minimal attention or small amounts of saving will compound and produce larger gains in the future. By establishing a systematic strategy now, you will help your child have more college options, avoid or minimize long-term student loan debt and succeed at the school of their dreams. 

Start today no matter the age of your child. Families with younger children sometimes fall into the trap of thinking saving for college can be delayed because they have many years to catch-up. Unfortunately, the lost time cannot be regained. A family that saves $1,000 on a child’s first birthday and adds $100 per month until the child turns 18 will save approximately $31,200 assuming a 4% interest rate and daily compounding. If they start on the child’s fifth birthday, the nest egg will be approximately $22,150 and only about $12,700 if they wait until the 10thBirthday.

Pick a savings plan that works for you. Some college savings plans, including 529 Savings Plans and Coverdell Education Savings Account, benefit from substantial tax advantages. On the federal level, the investments grow tax-free over their lives and can be withdrawn without paying taxes as long as they are used for school-related expenses. Many states also sweeten the pot with tax breaks. 529 plans are very popular among college savers, but there are other ways to save for college.  In addition to purchasing U.S. Savings Bonds, college savers use traditional brokerage and bank savings accounts.

Crowdfund. Saving for college is a family affair. Encourage relatives and friends to include college savings in their gift baskets for birthdays and holidays. Some credit cards also direct cashback rewards to college savings. Most 529 plans have online gifting programs and accept deposits from gift cards that may be purchased at retail stores.

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529 Plans 

Although few families can save enough to fully pay a college bill, it makes sense to save as much as possible given your family’s financial position in order to minimize college borrowing in the future. Saving a dollar today is better than borrowing one tomorrow.^® This simple example shows why:

• Saving: $100 per month saved with a 4% rate of return compounded annually over 18 years will provide $31,336 to pay for college. 
• Borrowing: At the start of college, let’s assume a student borrows $31,336 with an interest rate of 4% and a 10-year repayment schedule: the monthly payment starting six months after graduation would be $371, assuming the student does not pay interest while in college. The total amount repaid is $44,543.
• Conclusion: Saving a smaller amount ($100) each month over a longer period of time (18 years) eliminates the need to borrow, pay $317 per month and total interest of over $13,200.

529 Savings Programs and Coverdell Education Savings Accounts have become very popular because each offer tax-advantaged opportunities to save for college. Earnings on the accounts accumulate tax-free and distributions made for college expenses are also tax-free.

The primary differences between 529 Accounts and Coverdell ESAs is that Coverdell has income restrictions (your Adjusted Gross Income needs to be less than $110,000 for single filers, $220,000 for joint filers), a maximum annual contribution of $2,000 per beneficiary and a requirement to use savings before the beneficiary reaches age 30.

Here are some benefits of 529 College Savings Accounts:

1. No income limitations

There are no income limitations associated with the 529 plan. Plans do have total aggregate caps on the amount that may be contributed, but these limitations are only for contributions, not for the total account value.  

2. Tax-free growth

529’s offer the tremendous benefit of tax-free growth and the ability to withdraw the savings without paying tax as long as they are used for Qualified Education Expenses, which are broadly defined to include most expenses related to college.  In addition to federal tax advantages, many states offer state tax benefits as well.

3. It’s easy to switch beneficiaries

 Some parents are concerned that their child may not attend college or there may be money left over.  If that’s the case, the account owner may redesignate a beneficiary, including naming themselves. In the worst case, withdrawals for non-qualified expenses incur a 10% penalty and require taxes to be paid on the earnings.

4. Among the best savings options when considering financial aid

Families concerned that their savings may affect their eligibility for need-based financial aid should consider 529s. Ultimately, the way cash is saved is what’s most important. On the FAFSA (Free Application for Federal Student Aid) money saved in a 529 plan owned by the parent is weighed against financial aid eligibility at a maximum of 5.64%. For example, $10,000 saved in a 529 could end up reducing financial aid eligibility by $564. This is much better than having money in a standard savings account in the student’s name, where it can be weighed against financial aid eligibility up to 20%, which could be as much as $2,000 of reduced financial aid. The 529 provides a superior vehicle for college savings given financial aid regulations for higher education.

5. Great for estate planning

Grandparents find 529 to be a viable means of helping fund college for their grandkids while retaining control of their assets as part of their estate.  Money put into a 529 is removed from the taxable estate, but grandparents are able to retain rights of control over the 529 account even when funding is typically used to cover future college expenses for their grandchildren. With a 529 Plan, you are able to make a lump-sum contribution equal to five years of the annual $15,000 gift tax exclusion to a beneficiary in a single year. This means that you can give up to $75,000 (if you are single) or $150,000 (as a married couple) at once, per beneficiary, without having to pay gift or estate taxes. And, if the 529 funds are used by the grandchild in the last two years of college, the funds don’t need to be reported on the FAFSA form.

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Helpful Articles

• Saving for college isn’t just something parents should concern themselves with – kids and other family members can help contribute to a college fund for your child too. Read these tips for how to make planning for college a family affair:
• This article explains whether or not you can use a 529 college savings plan to cover the cost of online courses. 

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