I am pretty damn sure that I am not the only parent out here trying to figure out the best way to save money to send my children to college. Due to the rising costs of living compiled by the always rising cost of tuition, I have been doing a lot of research on this topic and would like to share with everyone the different solution out there as well as my own personal plan for my two children.
It’s never too early to start saving for college and your child’s ongoing educational expenses. These days, there is such a variety, it’s probably not a case of either/or so much as which investment options to include to create a tax-saving portfolio that will meet your family’s needs
Getting Started
The first step is to guesstimate how much it will cost to send your child to college for four to six years – the average time it takes to earn a degree. Calculate in-state and out of state tuition. Look at housing, food and transportation back and forth at least a couple of times per year, with books and incidentals added on. Get your target number. Scary, huh?
There are millions of tools on the internet that can help you do this and a quick google search can be your friend. To be helpful, here are some of the tools I used:
College Savings Calculator – Personal Capital
College Savings Calculator – Fidelity
MESP College Planning – Michigan 529 Plan
For the 529 plans, you can generally find a calculator for each and every state specific option although they are all basically the same.
Choosing the Right Plan
529 college savings and prepaid plans
529 plans are the most popular education-specific savings plan. They are similar to a 401k in terms of choosing investments. In some cases, they are a pre-paid tuition plan.
A 529 savings account allows you to invest in mutual funds or other investment products with the same risk and return on investments of other stocks and shares. Pre-paid tuition plans allow you to effectively “lock in” tuition costs and avoid the impact of ever-increasing fees. Each state administers their own 529 account, so options vary. Many states offer tax breaks or credits to residents. Some even offer matching funds if you contribute. Your after-tax contributions will grow tax free.
Coverdell Education Savings Accounts (ESAs)
Education Savings Accounts (ESAs) are similar to a 529, and offer tax-free growth. But contributions are limited to $2,000 per year, and only until the beneficiary turns 18. There are also income limitations. The main advantage is that they offer more flexibility than 529 plans, with educational expenses from Kindergarten to grad school eligible.
Coverdell ESAs allow money to grow tax-deferred and withdrawals are tax-free at the federal level (and in most cases, the state level) when used for qualifying education expenses.
Savings Accounts
Savings accounts can be opened and the money used for any purpose, but the return on investment will be small. Typically, a savings account ranges from 0.01 to 0.1 on average and this means all money put in will grow at a slow and negligable difference.
IN my opinion this is the absolute worst method to use to save money for anything!
Roth IRAs
A Roth IRA uses after-tax contributions and will grow tax free. Withdrawals from a Roth are allowed penalty free for qualified education expenses, though they will generally be included as income in determining financial aid eligibility if they are in the name of the parent rather than another relative.
If your child gets a lot of scholarships, the money can keep growing for your retirement.
There are some drawbacks here that I think are important to mention. First off, it take money out of your retirement fund and this money cannot be put back in unless you happen to still be working. This means that you will need to ensure you are well funded up front for both retirement and the college costs. Second, the IRA distribution is counted on the follow years financial aid application as income and it will possibly impact your Childs eligibility.
There are work arounds in which you can set up the Roth IRA in your childs name but this is something we will discuss in future articles. For now let’s not look into the specifics here.
CDs and Savings Bonds
These both carry low interest rates these days that don’t keep up with inflation. But savings bond income is tax free if used for educational purposes.
Trusts
Trust accounts are assets transferred to a child’s account and invested on their behalf until they reach the “age of trust termination” as defined by the state in which they live – usually between 18 and 21. They can then do what they want with the money, such as pay for college or backpack around the world. Once the money is theirs, it can affect their financial aid eligibility. There are some tax advantages for those making contributions to the trust.
Although there are no limits on contributions, parents and grandparents can cap individual annual contributions at $15,000 per individual ($30,000 per married couple) to avoid triggering the gift tax.
One thing to be aware of is that custodial accounts count as students’ assets (rather than parents’), so large balances can limit eligibility for financial aid. The federal financial-aid formula expects students to contribute 20% of savings, versus a maximum of 5.6% of savings for the parents.
Next Steps
Once you have an idea about your Childs savings needs as well as the methods you plan to utilize for achieving the goals, it is time to being saving that money. This step is the most important and the reason why always strikes me as odd however, most people never actual start and it is because the task of saving money always feels so insurmountable.
For most families, paying for college is not as simple as writing a check each quarter. Instead, it’s an amalgamation of financial aid, scholarships, grants, and money that the child has earned as well as money that parents and grandparents have contributed to tax-smart college savings vehicles.
Due to this the best thing you can do for your next steps it to “JUST BEGIN” with what you can and grow grow from there. Once you start and see how much of an impact your family faces you can best assess and adjust your plan, goals, or even additional income streams.
My Personal Plan
I always like to include my person information in most of my posts to help give a sense of where my mind stands and what I think is the best option for my personal situation.
I currently have two children, ages 3 and 1, and my goal is to pay for their college fully. I know there are a lot of opinions around this but for my personal beliefs and goals, this is something I feel is important and something I want to do to support my children’s futures.
Given this I am going to be using 3 of the methods above to help maximize my personal tax benefits as well as ensure my growth options are as broad as possible. I will not go into full details around the financial figures but here is what I believe will work out best considering we are a full time working family as well as having methods or making additional money on side jobs.
1. Both kids will have their own 529 plans and currently do. The plans were opened on or near their 1st birthday and have annual contributions from parents and grandparents. This is by far my favorite method and I always ask friends and family to send money to these accounts rather than giving cash for birthdays or presents.
2. Trusts, I plan to have a trust set up by the age of 5 for the children. Since I am planning to pay for their college fully, I am not worried about financial aid and I am preparing for the children to get very little if anything at all. I know this is not something everyone can do but I currently have the luxury of this and I hope to maintain that for the near future. I look at this as both a college savings as well as just an overall gift to them when they are ready to start their lives.
3. Roth IRA owned by each child, I said we will talk about this in a different article so all I really want to say here is that once each child is 4 or 5, depends on when I can realistically get their support, I will put them on payroll for my LLC and put the entire pay into a Roth IRA for each of them.
My goal as I mentioned is to do whatever I can to benefit my personal taxes as well as my kids. Let me know in the comments what you are considering or if you have a different idea that I could look in to.