Imagine being able to save enough money to put your child through college debt-free.
That’s no small feat, given that the cost of a college education continues to rise, and the average college graduate’s student loan debt is at an eye-popping $37,172. If your child decides to go to graduate school, then you’ll need to shell out even more. The average debt load of a student with a master’s degree is $51,000, and if your child plans on going to medical school, it will be over three times that amount.
As a parent, you don’t want your children to begin their journey into adulthood shouldering a huge mountain of student debt. But at the same time, you still can’t ignore your own financial needs. Not only do you need to meet day-to-day expenses, but you also need to make sure you are saving regularly and consistently for your own retirement.
Saving for children while not ignoring your own money goals may be a challenge. But that doesn’t mean it isn’t doable. The key is to use tax-advantaged methods to help speed your results.
Here’s an overview of tax-advantaged strategies to help your child with his or her college expenses:
The 529 Savings Plan
One of the most popular options for parents wanting to put money aside for their child’s college education is the 529 savings plan. These plans are investment accounts that offer tax-deferred growth. Then, withdrawals for qualified education expenses are free from federal income tax (and usually state tax, too).
These accounts are flexible and allow parents, grandparents, or others to contribute to your child’s account. You can contribute up to $75,000 (or $150,000 per married couple) per year to a child’s account without being subject to federal gift tax. Please note this may vary depending upon your state of residence, too.
Overall, 529 plans are a great option if you can start early and make continuous monthly deposits. Because these are normally invested in stocks or mutual funds, you get the benefit of compounding returns over longer time frames. However, you also run the risk of the market not being where you’d like it to be when the money is withdrawn. That makes this most appropriate only if you have a long time frame.
Coverdell Education Savings Accounts
Similar to the 529 college savings plans, Coverdell Education Savings Accounts (ESAs) allow parents to make contributions with after-tax dollars to an investment account and have their money grow tax-free. Withdrawals can also be made tax-free as long as the money is being used for qualified educational expenses.
Unlike 529 saving plans, however, ESAs are much more flexible when it comes to the kinds of educational expenses that qualify without incurring a penalty. In addition to college tuition, money can be used to help cover primary and secondary school tuition, as well as a range of related supplies and services, such as uniforms and tutoring help.
The biggest drawback to the ESA is the low yearly contribution limit. You will only be allowed to contribute up to $2,000 a year per beneficiary.
Prepaid Tuition Plans
If you plan on sending your child to an in-state public university, then you may want to consider a prepaid college tuition plan, also called a prepaid 529. This plan allows parents to buy credits in advance to lock in tuition prices at today’s cost.
Prepaid college tuition plans are a good option if you are starting out late and don’t want your buying power subjected to stock market volatility. They are also a great alternative to most short-term investments, such as CDs and money market accounts, which will only generate a 2 percent return at best. This is due to the fact that these plans basically offer a rate of return that follows the rate at which college tuition increases, generally 4 to 6 percent annually. Moreover, prepaid 529 plans offer the same tax benefits as the standard 529 savings plans.
One major drawback to this method of saving for college is that if your child decides to go to an out out-of-state school, you won’t get the benefit of having locked in the predetermined price. Instead, you or your child would need to make up the difference out of pocket.
Additionally, prepaid 529 plans are getting harder to find, as the rising costs of tuition have made them difficult to administer.
Get Your Kids Saving Too
In addition to the plans mentioned above, we also recommend getting your children involved early on with their own savings fund. Not only can this help defray the costs of attending college, but it will also allow them to build healthy money habits that they can draw on in the future. And you can’t get a better return on investment than that.
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