Saving for Your Children's Education: Growing Goals
A college education doesn’t come cheap. To factor the cost of attending a college or university, or COA, you have to include tuition and fees, room and board and books and supplies. For 2019-20 the average cost of attending a public school at an in-state rate was $25,707 per year. The average cost of a private 4-year university was $54,501 per year. And that is just what it costs right now if your child is already 18 years or older and enrolling in college.
If you have younger children at home expect the cost of college to continue to rise. One estimate says the cost of a college education is rising eight times faster than wages. If one of your long term financial goals is to get your child to college graduation with the least amount of educational debt possible, it’s never too soon to begin saving for your children’s education.
Where Do You Begin Saving For Your Children’s Education?
It may seem overwhelming to think of the tuition checks you’ll be writing in the years to come but to begin saving you need to develop a plan.
The first thing is to begin saving as early as you can. It’s not unreasonable to begin setting up special college savings accounts and budgeting for that savings as soon as a child is born. If you didn’t start at the very beginning, jump in anytime and get started saving for your children’s education.
Set a Realistic Goal
If your child is enrolling in college soon you can plan on needing savings in the neighborhood of $25,000 a year if you need all of the cost to be covered by savings. While you’re being realistic you can decide how much of the cost of college you can absorb as a regular living expense. Maybe it’s realistic that $5000 can come just by budgeting daily expenses differently. Maybe there is a big end-of-year bonus that can be applied to the cost of college.
The College Board offers an online calculator to help you estimate what college is going to cost in the future. You plug in a formula with the cost of tuition in today’s dollars and the calculator adjusts the total by the number of years in the future plus allows for inflation.
Once you know what you need it is time to set up a budget to try to get you to your financial goal of saving for your children’s education.
Create a Family Budget
The best tool for seeing how much money is coming in and where it’s being spent on the way out is a family budget. When you work through income and expenses for a budget you also carve out savings to reach your good financial goals. Ideally, you are putting money away for an emergency fund of living expenses, you are funding retirement savings and you are saving for your children’s education.
A budget can be set up in many different ways. Some families like an old-fashioned yellow legal pad with a line down the middle that divides income from expenses. People who are fluent in spreadsheets like to set those up so that the program is making all of the mathematical calculations. There are also apps that allow you to input data and track your progress and analyze where you are in the budgeting process with colorful graphics and charts. There is no right or wrong way to set up the physical look of the budget. It just has to make sense to you and be easy enough to use that you will keep coming back to it.
Income - The first part of the budget is the income part. How much money can you reasonably expect to have coming in each month? This is easy enough for traditional, salaried workers and more difficult for employees who work on commission, small business owners and independent contractors. In those cases just work with an average of the last three or six months or so.
Expenses - The second part of the budget revolves around fixed expenses. These are the costs of living. Housing, utilities, food, transportation, clothing, personal items as well as other obligations like loan payments. While it is possible to tame some of these expenses they are a part of every budget.
When you compare the two columns hopefully income is higher than expenses and what you have leftover at the end of the month is for savings. If more is going out than is coming in before you can begin saving for your children’s education you’ll have to adjust expenses. This is where you sometimes have to make hard choices.
Common places in budgets that can be reduced are the amount of money spent eating out and the amount of money being spent on technology and subscription services. If you think you can cook two more meals at home a week or drop your cable television subscription and only us streaming services, you may have uncovered the extra money in the budget to save.
Most financial planners recommend that the very first payment you make after receiving a paycheck is to yourself. That means funding the savings upfront and getting it out of your checking or debit account where you might access it in a weak moment on a brand new pair of shoes or a dinner at a trendy, new bistro. And remember the three things you need to fund: emergencies, retirement and college. You may also want to set aside additional savings to take a dream vacation, buy a new card or pay off a credit card with a balance. Define what your financial goals are and budget accordingly.
Now that you have zeroed in realistically on how much you can save for college, you have to decide where to put your money so that it can work the hardest and grow the most. Here are some of the options for saving for your children’s education.
529 College Savings Plans
529 savings plans are formally known as qualified tuition plans and operate under Section 529 of the IRS code. 529 plans are sponsored by states, state agencies, and some educational institutions and are used for the purpose of saving for college expenses that will be coming at a future date. There are two types of 529 plans to know about when you are saving for your children’s education.
Prepaid Tuition Plans
Prepaid tuition plans allow the saver to purchase college credits at today’s prices to use in the future. Most prepaid tuition plans are sponsored by individual states and have residency requirements. In many cases, it is enough for the child to have been born in the state sponsoring the 529 plan. Other states require the student to be living there before enrollment.
Since individual states create these plans the rules and regulations vary widely. Generally, withdrawals from these plans have to be for the actual cost of tuition and not room and board.
Educational Savings Plans
Educational Savings Plans, or ESPs, give savers mutual fund options for investing the money they are saving for college. Money can be withdrawn from ESPs to not only pay tuition and fees but also room and board. ESPs give you the option of saving for your children’s education not only for college but for before that as well. The saver is allowed to withdraw up to $10,000 a year from an ESP to pay for a private or religious elementary school or secondary school.
Some ESP options allow the saver to selected targeted-date portfolio options. That means taking on more investment risk when the child is younger and taking a more conservative investment approach as the child gets closer to college.
ESPs are usually run by individual states but do not typically have residency requirements.
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What’s the Fine Print?
Before investing in any kind of college savings plan it is important to thoroughly read and understand the fine print and make the best decision for your family.
Fees-Saving plans may charge enrollment fees and ongoing administrative fees for the life of the account. Sometimes fee structures change if the saver has achieved a high balance or makes electronic contributions.
Restrictions-Different savings plans have different restrictions on what the 529 money can be used for. Some plans guarantee the saver will never lose prepaid college credits, but not all do.
The tax advantages of investing in 529 plans vary by product and by state.
All 50 states and the District of Columbia sponsor at least one 529 college savings plan. The National Association of State Treasurers has a roundup of them here.
The Uniform Gift Act to Minors
Parents can transfer money to a special account for their child under the federal Uniform Gift Act to Minors. This is an easier way of saving for your children’s education than opening up a formal trust fund. Under the Uniform Gift Act to Minors, the account invests in stocks, bonds and mutual funds on behalf of the minor and it is managed by a custodial adult until the minor child becomes of age.
The earnings on this kind of account are taxed at the lower rate for the minor. During the life of the account, other friends and family members can make contributions. The funds in this account are also accounted for if the student applies for federal financial aid. One thing to take into consideration is that once the child is legally an adult, he or she is free to use the money in the account any way they like – not necessarily to pay for a college education.
What If We Can’t Save Enough?
Even the best savers with the tightest budgets may not be able to completely fund the cost of college, especially in a family with multiple children. Contribute as much as you can and then investigate how much federal student aid you may be eligible for.
Student Aid
The first step in that process is to fill out a FAFSA, or Free Application for Federal Student Aid. The government uses this information to qualify families for grants or loans. Grants are financial gifts that do not have to be paid back. Federal student loans do have to be paid back with interest. Federal student loans offer undergraduate and graduate students some of the most competitive interest rates. The government also offers different kinds of repayment plans for after the student leaves school.
Student Loans
There are also private lenders who specialize in student loans. Many of them offer online applications and can match a student with lenders in minutes. Interest rates are higher on loans from private lenders than they are from the federal government. And private lenders don’t usually offer flexible repayment terms on existing loans. To change the repayment terms you have to refinance or consolidate into a new loan.
Should Our Student Contribute To the Cost of College?
It’s a personal decision within each family whether or not the student is expected to also contribute while you are saving for your children’s education. Some families take the gifts of money that arrive at birthdays and holidays and add them to the college savings fund. Sometimes high school graduation gifts go straight into the savings.
Other times the student will be expected to work in the summer and/or the school year and contribute some income to the savings account. And when it comes to the savings account, we suggest that you take a look at the table below and find the one that works best for you:
One thing to remember is that every dollar saved or spent out of pocket for college, is one less dollar with interest that will have to be paid back later.
Dave Ramsey Approach
Financial guru Dave Ramsey has some ideas about paying for college.
First and foremost Ramsey believes in saving for your children’s education and paying cash for it, and not taking on any debt. Student loan borrowers in the United States owe a collective $1.76 trillion in federal and private student loan debt as of September 2022, according to the most recent quarterly tally by the Federal Reserve. And some of those borrowers will be paying the money back for as long as 30 years. Ramsey is in the business of teaching people to crush their debt and live within their means.
He also advises every family to fill out the FAFSA form and take note of what their expected family contribution is. That’s the number that colleges and universities will look at when they are awarding grants and loans.
Ramsey advocates selecting a college with tuition that matches the amount of money you have been saving for your child’s education. He does not believe in going into deep student loan debt when there are more affordable options. He also suggests that families consider community college as an economical jumping-off point for higher education. Two years later the student should have an Associates Degree and easily transfer into a four-year school. That is also two additional years to save money for college.
He also points out that a traditional four-year college education isn’t for everyone and that some students are more suited to attending a technical school and learning a trade.
Look for Scholarships
Ramsey advocates for searching for scholarships. Applying to scholarships and filling out each application well is a lot of work. But it can pay off with free money for college that does not have to be repaid. Don’t shy away from local scholarship opportunities even if they are just a few hundred dollars. A handful of those scholarships will add up and reduce the potential amount of a loan.
It is also possible that college student can work while in school and contribute to the cost. This could be an off-campus job or it could be a formal work-study program through the school that pairs an on-campus job with a paycheck.
Conclusion
The price tag on a year at a college or university can easily run into tens of thousands of dollars and continues to rise at a pace faster than wages. That’s why so many families take college savings so seriously.
Begin saving for your children’s education as soon as you can. Dollars tucked away when they are babies will have had the chance to compound and grow through the year. No matter how close they are to heading to college, create a savings goal of what it would take to fund that education. Come up with a plan to save by creating a family budget. Analyze income versus expenses and what is available to put into savings and what could become available with lifestyle changes.
Once you have the budgeted savings determine where you will keep the money. There are 529 College Savings Plans that allow you to buy tomorrow’s credits at today’s prices. And there are Educational Savings Plans that park your savings in mutual funds with the hope of growth. And even if you can’t save enough to cover the entire cost of college, you still have options to bridge the gap out-of-pocket, or through scholarships, grants or loans.