Has the thought of paying your child’s college tuition given you fits at night? Was it one of the first things that ran through your head even before she was born? Believe it or not, if your child’s college tuition has been on your mind since she was in the womb, you are not alone.
Despite oft-repeated stories of highly successful individuals who dropped out of college e.g. Mark Zuckerberg, Bill Gates, and Steve Jobs, remaining in school as long as possible is still the best way to raise one’s income and future job opportunities.
Therefore, parents who instill in their child the value of a college degree are on the right track. However, many of them haven’t devoted nearly enough time figuring out how to pay for it. According to Sallie Mae, only 6 in 10 parents put money away for their children’s college and have an average of just over $18,000. Unfortunately, that sum wouldn’t cover the first year at an in-state public university.
Although saving up for your child’s college tuition may seem like an insurmountable goal, it is possible with an early start and some careful planning. I’ve included a few tips below to get you started on the right path to your child’s debt-free university education.
Cement Your Own Future Before Taking Care of Theirs
Keep in mind that you are much closer to retirement than they are and don’t have the same amount of time to pay off their student loans. In other words, manage some of your outstanding debts before you jump into your children’s.
Some of the things you need to take care of beforehand include your credit card debt and any student loans you may still have left over. At the very least, establish a plan for paying these things off as soon as possible. You also need to put aside the customary three to six months of expenses in case of emergencies. Many financial professionals also recommend putting aside as much as 15% of your income in a retirement fund such as a 401(k) or an IRA. Once you’ve got these basics covered, then you can start preparing your child’s college fund.
Education Savings Account (ESA)
A good place to start is with an Education Savings Account (ESA) or Education IRA which allows you to put aside $2,000 after taxes per year per child. Since it accumulates tax-free, you could invest up to $36,000 by the time your child turns eighteen. The advantage is that the money can earn a much better rate of return than in a normal savings account, and no tax money is due upon withdrawal of the funds for education costs.
In order to get a handle on college costs for anxious parents, Fidelity Investments devised a rule of thumb a few years ago. They suggested multiplying your child’s age by $2,000 to cover about half of the cost of a four-year, public, in-state university. In other words, you should have about $16,000 saved for your eight-year-old to hit that mark. The great thing about an ESA is that, if managed correctly, it should provide for well over half of your child’s total college costs due to the interest and growth it incurs over the years.
The 529 Plan
529 Plans accomplish the same basic goals as ESAs except they allow for more aggressive saving. You can contribute much more to this account (typically up to $300,000) while it also grows tax-free. Unlike an ESA, however, there are no income limits. Look for a plan that lets you choose what type of funds you invest in through the account. In this way, you will at least have a say in how the money is being invested. A key point to remember is that the savings in a 529 are the property of the parent, not the child designated as the beneficiary.
One terrific option still offered by some states is the prepaid tuition plan. If it is likely that your child will attend an in-state public university, this is a great way to go. These plans enable parents to purchase tuition at one of their eligible state universities at current rates for their child. Essentially, you are loaning money to the state at the time of purchase in exchange for the guarantee of that rate when your child goes to college. The downside is if your child winds up going to a school out-of-state. In this case, it is likely that you will get a credit towards their tuition, but you may not get the full value of the money you invested with your state plan.
Involve the Student
Another helpful hint is to involve your child in the process as soon as possible. They can start their own savings fund and use that money not only for college but also for services that will prepare them for college like tutoring or test preparation. The more that they take ownership of the process, the better prepared everyone will be by the time they are ready to enroll.
Pay Now or Pay Later
Since the majority of financial aid comes in the form of loans instead of grants, most parents will need to have a significant amount saved to keep from plunging themselves, or their child, into burdensome student loans. The bottom line is that the time to start saving is now. In other words, save early and regularly, so that there’s time for your money to grow. Due to a 5% average annual increase in college costs, parents need to use the power of compound interest in order to keep pace. Neither the student nor the parent should suffer from student loan debt long after the diploma has been awarded. As always, it is less expensive to save now instead of borrowing later.