By some measures, tuition has increased an average of 8% every year in the last 25 years. What does this mean for your child? A child born today could face a tuition bill three to four times over what a college student pays today. One estimate holds that scholarships and grants cover less than half of all college costs, on average (with the rest coming from savings, investments, and debt). Thus, it's imperative not only to save for your child's eventual college costs, but to start now.
Parents seeking to begin a savings plan for education costs have several options available to them. Which one is best suited for your particular needs depends heavily on individual circumstances and goals. There could also be tax consequences for each of these options, so readers are urged to consult with a tax attorney or CPA prior to making any final decision. This article will give you an overview of the options available, and some of the advantages, and disadvantages, of each.
Where to Begin
Before putting one dime away, you'll need to do a little planning.
- Estimate your needs. How much will your child need for college? Consider all potential sources of funds. Do you expect your child to contribute to his own education? Many parents do, and it's certainly a good idea to teach economic responsibility at a young age, before the college student gets hit with the inevitable deluge of credit card offers. However, child labor laws and the reality of being a teenager make it almost impossible for your kid to finance his college completely on his own.
Make estimates of these figures: tuition costs, room and board, gifts already received from grandparents or other relatives, child's own savings. (If you have more than one child, multiply the cost estimates accordingly.) These certainly won't be firm numbers, but having these estimates will serve two useful purposes. One, it will give you a goal to keep in mind while planning the vehicles in which you will save your hard-earned cash. Two, it will undoubtedly scare you a little bit. However, fear can be a terrific motivator, when it comes to saving money.
- Estimate how much you can reasonably put away on a per-month basis. Everyone's needs are different, and though your neighbor might be able to boast of depositing $1,000 a month into Junior's 529 plan, that may not be possible for you. The key is to arrive at a figure that's workable, that you can commit to, and stay committed to, for the long haul. If the figure's too high, you'll inevitably skip a month's deposit at some point, and that will make it all too easy to skip the next month's and the next ... and the key is to keep making steady, regular progress until your child graduates from high school.
- Figure out how much you will have by the time graduation rolls around. The Internet abounds with savings calculators that can help you figure out various permutations on a theme - assuming a deposit of "X" dollars, over "Y" years, at an interest rate of "Z" %, the total yield will be $_____. Use these calculators and play with the numbers a bit. What happens when you find a better interest rate of even a fraction of a percentage point? What happens if you skip a month's payment, or make an extra payment? If you adjust the deposit up or down a few dollars?
- Make adjustments for more than one child. If you have more than one child that will be attending college, your efforts will be spread more thinly, of course. So you need to consider the effect this will have on the bottom line. Look for more aggressive vehicles, but be aware that greater potential payoff also carries a greater risk.
Looking at the Options
Now that you have an idea of what you're up against, it's time to take a look at your options. You can pay for school any number of ways, but most people use a combination of the following: assets (hard assets or investment accounts, converting them to cash); savings; incurring debt (you, your child, or both); and grants and scholarships. A brief word about each option:
- Assets are items such as second homes, artwork, vehicles, jewelry, etc., but also include investment accounts and other financial vehicles in which you've accumulated funds. (We're excluding savings accounts for the purpose of this discussion only, in order to distinguish the methods, but savings accounts would be considered an asset). Essentially, an asset (as we're using the term here) means "anything you can convert to cash by selling your interest in or title to the property."
- Savings means just that - funds you've saved in an account set aside for that purpose. Most people use savings accounts, though the interest rate on such accounts is pitifully low (there are other options available). In addition to monies you've accumulated over the years, or that your child set aside from babysitting or mowing lawns, savings (for purposes of this discussion) will include gifts from other sources, such as grandparents.
- Debt means loans, plain and simple. You can incur debt as the parent, using assets as collateral, or you can apply for an unsecured loan (which is not tied to any collateral). Or, either as an alternative or in conjunction with debt incurred by a parent, the child may be eligible for student loans.
- Grants and scholarships are essentially "free money." They may have strings attached to their acceptance (i.e., maintaining a certain Grade Point Average, majoring in a certain field, etc.) but they usually do not need to be repaid.
Putting It All Together
Your next task is the complex part: taking into consideration where your family's finances stand (i.e., credit scores, ability to put funds aside, a killer art collection, wealthy in-laws that dote on the grandkids, etc.), decide which of these options you can include in your plan, and to what extent. If your family has one breadwinner, and that salary is completely apportioned amongst all the bills, leaving $100 a month disposable income, then obviously you're not going to be able to rely 100% on savings alone. You'll need to look for other options, such as scholarships and debt. But if you're lucky enough to have that killer art collection (and you're amenable to parting with it), by all means have it appraised and make that a primary part of your plan.
Grants, scholarships, and loans are fairly "last minute" options - you apply for those at or near the time your child applies to colleges for admittance. Likewise, you'll probably want to wait to convert assets that appreciate (this would exclude assets that actually lose value, like cars, unless it's a classic/antique vehicle). It's the savings portion of the plan that probably needs your attention and efforts immediately. So let's take a look at your options:
- Savings accounts are accounts managed at financial institutions which typically carry the lowest interest rate of all your interest-bearing options. Unless you're assured of contributions exceeding needs, you can do better. Look into options besides the savings account unless you're exceedingly risk averse.
- Certificates of deposit carry certain terms (6 months or 12 months being most common, although they can be rolled over) and a slightly higher interest rate than savings accounts. Deposits are typically insured up to $100,000.
- Coverdell Educational Savings Account (formerly known as an Education IRA). These accounts are governed by IRS regulations (for more information, see the IRS page here). Briefly, however, these accounts can receive up to $2,000 in deposits yearly, and are restricted to use for any qualified education costs. If the conditions imposed by law are satisfied, the distributions to the beneficiary are tax-free.
- UGMA/UTMA Transactions . These are transactions in which gifts are made to the minor child by others (usually parents and other relatives). There are significant risks to putting assets in the child's name, however (see below).
- Withdrawals from your retirement plan . Withdrawals made to pay qualified higher education costs are exempted from the 10% additional penalty otherwise imposed on withdrawals from IRAs before age 59.
- Treasury Bonds . Bonds are debt to the bond issuer, so Treasury bonds are considered fairly safe investments, bearing a steady rate of interest. However, the safety of the vehicle also means the interest rate won't be that high. Regardless, treasury bonds should be considered as part of a comprehensive education savings plan.
- Section 529 plans . While the details vary state to state, 529 plans (aka "Qualified Tuition Plans") are named after section 529 of the Internal Revenue Code. Plans can be either prepaid tuition plans or college savings plans. The prepaid plans lock in tuition, but carry more restrictions; the savings plans are more flexible, but carry no guarantee. If the plan qualifies under the IRC, then participation is tax-free. There are plans in every state, and an Independent 529 plan as well. For more information on these plans, see http://www.finaid.org/savings/529plans.phtml.
- Credit Card Rebate/Loyalty Programs . Many card issuers have programs whereby cardholders (not only parents!) can sign up to have a portion of their purchases go to an account set aside for funding college costs for a particular child. This is a terrific way for relatives to participate. Examples are Upromise, BabyMint, and SAGE Tuition Rewards.
Before you put one dime in any of these vehicles, however, consider the impact on your child's future application for financial aid.
A word of caution: there can be extremely negative consequences that flow from putting savings accounts in the name of the child which far offset the meager tax savings you will receive from doing so. In short, financial aid evaluations will look first to the child's assets. Since a savings account is considered an asset, a large balance (coming from years of faithful deposits by Mom and Dad) can actually make it harder for Junior to qualify for aid! Additionally, monies that are in the child's name legally belong to that child. What happens when Junior decides to backpack across Europe instead of hitting the books after high school graduation? He'll be entitled to use funds that are in his name (unless some other mechanism conditions the use of the money). An excellent chart can be found at FinAid.org which covers the impact of most of the key vehicles for education funding on the Free Application for Federal Student Aid (FAFSA).
Some General Tips
Finally, here are some general tips to help you get started and stay on track with savings:
- Start early, and make regular deposits. Acts which we do regularly become habits, and the habit of saving money will not only help you reach your goals faster, it will also teach your child a powerful lesson that will serve him well in life. Obviously, the earlier you start, the better off you and your child will be in the long run, and the less you have to put away each month!
- Make savings automatic. You can't miss what you don't see. Ask your employer about directly depositing a portion of each paycheck into a savings vehicle of your choice.
- When windfalls come (sweepstakes winnings, gifts, bonuses at work, tax refunds, etc.), don't spend them - put them aside into the savings vehicle you've set aside specifically for the purpose of paying educational costs.
- Look critically at your living expenses. Almost everyone can find a substantial source of funds they didn't know existed just by reevaluating habitual purchases. Do you really need to see every new-release movie in the theater? How about that $5.00 coffee drink you indulge in daily? It all adds up. Make the hard choices now, and it will pay dividends for years to come.
- Make your expectations of your child known to him or her up front. Don't wait until your son or daughter is applying to college to let them know you expect them to pay for their own room and board. Let them know as early as you can (i.e., as soon as you make the decision and they can intellectually grasp the concept) just what, if anything, you expect them to contribute towards their education. Let them in to the planning process. This gives them a sense of ownership in the goal and can get them excited about saving.