Paying for college is the biggest expense many parents will face outside of retirement. Yet many delay saving for it - often because they’re not sure how much they’ll need.
Saving for college is like aiming at a moving target. While the College Board reports that an all-expenses budget for an in-state public college student averaged $25,290 last year, tuition costs are rising by 6 percent every year and babies born today can expect to pay an average of $54,000 per year by the time they reach college age.
According to Sallie Mae, six out of 10 parents stash their college savings in a regular savings account. In fact, 40 percent of all college-savings dollars are kept in low or no-return vehicles such as checking or savings accounts. That means the majority of parents are missing out on the opportunity to grow their savings.
That’s why an increasing number of parents are using 529 savings plans to give their child’s college fund a boost. A 529 plan is a tax-advantaged investment account that earns a higher compound interest rate than a savings account, allowing parents to make a bigger dent in tuition—especially those who get an early start.
Why use a 529 college savings plan?
Unlike a savings account, the money you put in a 529 plan doesn’t just sit there. It’s invested, which means it has the opportunity to grow at a faster rate.
For example, if you put $100 into a savings account every month for 11 years, at an interest rate of 1 percent, you’d have about $13,900 by the time your child goes to college. If you put the same amount into a 529 plan with a 5 percent annual interest rate, you’d end up with more than $17,000.
There are other benefits too. Not only are contributions to a 529 plan tax-deferred, but the interest you earn on your savings generally isn’t taxed as long as you use it for qualified educational expenses such as tuition, fees, books, or room and board. Plus, many states offer a tax credit or deduction for investing in their state-sponsored 529 plan.
How much should I save?
Since the cost of college varies widely depending on factors like where students go to school or whether or not they qualify for financial aid, there are no specific guidelines on how much to save. However, to arrive at a starting point, you can use the 2K rule: Multiply your child’s age by $2,000, and that’s how much you need to invest in your 529 plan to stay on track to cover half the average cost of a four-year public university.
What are the alternatives to a 529 plan?
If you’d rather not use a 529 savings plan, there are other ways to invest your child’s college savings. For example, you can use:
- Roth IRA
- Taxable investment accounts
- Coverdell Education Savings Account
- Uniform Gift to Minors Account or Uniform Transfer to Minors Account
What if I haven’t saved enough?
If your child is approaching graduation and you still haven’t saved enough for college, don’t panic—you still have options.
Students who qualify for financial aid can often get a combination of grants, work study and student loans to help cover the costs. There are also a multitude of scholarships available, so check with your child’s guidance counselor and the college financial aid office to see what’s available. Don’t forget to ask your employer about scholarship opportunities.
If you still have costs to cover, consider a private student loan. With a private loan, you can cosign for your child, there are no prepayment penalties and excellent credit can net you a lower interest rate. Private loans usually allow higher borrowing limits too.
Bottom line, saving for college isn’t an exact science. The most important thing to do is make consistent contributions while giving your money as much time as possible to grow. If you do that, your children will be in a great spot when they’re ready to start college.