Will we save for education?
To save or not to save
Saving for your child's education can be a wise decision. It'll help them manage rising education costs, reduce or avoid education-related debt, and may open up more educational opportunities.
However, it's not as clear-cut as it may seem. Not only is the cost of college education rising, but so is the cost of living in general, which may make it hard to contribute to education savings for your child - even if you want to.
Discussing your financial situation & budget
Start by discussing your financial situation and priorities. Look at your current income, expenses, and debts or financial obligations. This will give you a clear picture of how much you can realistically set aside for your child's education without straining your daily life and retirement savings.
If you want more information on budgeting for your baby, check out our article on this topic.
Estimating future college costs
To find out how much college may cost for your little one, you can use a tool such as the Massachusetts Educational Financing Authority college cost calculator, which estimates the cost of different types of US colleges based on the start year. This information can help you discuss how much of these costs you'll want to cover, if any.
College costs have been rising faster than inflation, so it might be wise to factor in a higher rate of increase when estimating future expenses.
Deciding on your savings goals
Once you have an estimate of future college costs and a clear picture of your financial situation, decide on your savings goals. Do you aim to cover the full cost of your child's education, or do you plan to save for a portion of it?
Some parents choose to fund their child's entire education, while others opt to cover a percentage, expecting their child to contribute through scholarships, grants, part-time work, or student loans. Discuss your expectations and goals to ensure you're on the same page.
Considering income & lifestyle changes once baby arrives
When planning your education savings, think about how your income and lifestyle might change when your baby arrives. Will one of you take time off work or work fewer hours? Will you need to pay for childcare when you go back to work? These factors can affect your budget and how much you can save for education. Your savings strategy can be flexible and should adapt as your situation changes.
Learning about your options
When saving for education, there are different choices, each with its own benefits and things to think about.
529 savings plans
State-run 529 savings plans let you invest in mutual funds, bond funds, and exchange-traded portfolios. They're similar to a 401k or IRA retirement plan, and your savings could go up or down depending on market performance. There are two different types of 529 savings plans:
- A direct-sold 529 savings plan is sold directly by a state financial institution. For these, you're responsible for managing your investments through their plan’s online account portal.
- An advisor-sold 529 savings plan is sold through an investment firm. For these, you typically pay a fee for the firm’s financial advisers to manage your investments.
These savings plans offer a state income tax break on contributions in more than 30 states. Earnings grow tax-free at both the state and federal levels, and when used for qualified education expenses for the account beneficiary, distributions are often tax-free, especially at the federal level.
Using 529s outside a college eduction
They can be used for tuition and fees for K-12 and vocational and trade schools, room and board, books and supplies, technology costs, and repayment of student loans. Since 2022, you can also roll over unused 529 assets to a Roth IRA for the 529 beneficiary, subject to certain criteria and limitations.
Many plans offer age-based funds that are designed to automatically adjust your portfolio over the years, investing more aggressively when your child is young and shifting to a more conservative approach as your child approaches college age. You can also transfer the plan to another family member, and there is no age limit.
Moreover, you can use money in a 529 plan for noneducational expenses; you'll just be charged a 10% penalty, and you may have to repay tax breaks on contributions.
Comparing 529 savings plans
Most states have at least one plan, and plans vary by state. Take a close look at fees, investment options, contribution options, tax benefits, and restrictions to evaluate which plan is best for your family - which may not be the one administered by your home state.
You can use this Forbes comparison tool or this Saving for College tool. Don't hesitate to ask plan administrators questions!
529 prepaid tuition plans
These let you lock in current tuition rates. You pay in advance for education at a particular university or group of universities. Only 9 states offer these plans for public schools: Florida, Maryland, Massachusetts, Michigan, Mississippi, Nevada, Pennsylvania, Texas, and Washington.
Unlike 529 savings plans, you may need to be a state resident to participate in its prepaid tuition plan, and options for redirecting or refunding money vary by plan.
The Private College 529 Plan offers a prepaid tuition plan for nearly 300 private schools in the US, including Stanford, MIT, and Princeton. Participating in a plan does not affect admission choices at these schools.
This plan allows you to change the beneficiary, roll over to another 529 plan, or get a refund - which may be subject to taxes and penalties.
Coverdell Education Savings Accounts
Coverdell Education Savings Accounts (ESAs) can also be used for tuition and fees for K-12 and college. They offer more investment options than 529 plans, and earnings grow tax-free, but contributions are not tax deductible. Distributions are tax-exempt as long as they are used to cover qualified education expenses; if not, you may be charged with a 10% penalty.
The beneficiary must use the money by the age of 30, but you can change the beneficiary of an ESA to another family member under the age of 30 without triggering taxes or penalties.
Uniform Gifts to Minors Act or Uniform Transfers to Minors Act accounts
You can also set up Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts. These are set up to benefit a minor but controlled by an adult custodian until the minor is legally considered an adult, which differs by state. Once the minor reaches adulthood, they have complete control of the account. They can use the money for any purpose - educational or otherwise - without any penalties.
Contributions aren't tax deductible, and earnings are subject to federal and potential state and local taxes.
The main difference between UGMA and UTMA accounts is the type of assets that can be held. UGMA accounts are limited to financial assets (cash, stocks, bonds, mutual funds), while UTMA accounts can hold other types of property, such as real estate, artwork, or patents, depending on state laws.
Other options
Traditional savings accounts or Certificates of Deposit (CDs) can also be used to save for college. While these options may not offer the same tax advantages as 529 Plans or Coverdell ESAs, they provide a low-risk, straightforward way to save.
Making a decision
Discuss these options, considering factors like tax benefits, how much you can contribute, and the rules for taking money out, and decide which works best for your family's finances and goals.
Also consider account ownership and how it may impact your child's financial aid eligibility when discussing these options. For example, assets held in a parent-owned 529 Plan have less impact on financial aid than those held in a student-owned account.
Automating contributions
Consider setting up automatic transfers to your child's college fund. Most banks and investment platforms allow you to schedule regular transfers from your checking account to your savings or investment account. Automating your contributions helps you stay on track and makes it less likely that you'll miss a month.
Boosting savings
While regular monthly contributions are important for your child's education savings, look for ways to boost your savings when you get extra money. For example, if you receive a tax refund, consider putting some of it into your child's college fund.
If you get a raise at work, think about increasing your monthly contributions. Also, when friends and family ask what gifts they can give your child, you can suggest they contribute to the education fund instead of giving toys.
Starting early
If you decide to save for your child's education, start early. Even small amounts can add up significantly over time, thanks to compound interest. For example, if you begin setting aside $100 per month from the moment your little one arrives, with an average annual return of 6%, you could have over $48,000 saved by the time they graduate high school.
Balancing with other financial priorities
While it's important to plan for your child's future, you also need to take care of your financial stability. Finding the right balance between college savings and other financial goals will help secure a future for you and your child.
Retirement savings
One key priority to consider is your retirement savings. Using retirement funds to boost your child's college fund might be tempting, but this can hurt you in the long run. Your child can find ways to pay for college, like scholarships and loans, but you can't borrow money for retirement.
Emergency fund
Another important part of financial planning is having an emergency fund. Life can bring unexpected events, like job loss or medical issues. A solid emergency fund—usually covering three to six months of expenses—provides a safety net.
Before putting extra money into college savings, make sure your emergency fund is sufficient. Also, consider paying down high-interest debt, like credit cards, before increasing college savings. Saving on interest can often be more beneficial than the potential returns from college savings accounts.
Additional resources:
we love your feedback!
