It doesn’t take a rocket scientist to figure out that college is expensive. The average student loan balance for the Class of 2016 was $37,000 and that figure is projected to increase with each future graduating class. As a parent, one of the last things you want to do is saddle your children with a mountain of student loan debt as they enter the workforce and begin having a family of their own. This guide will help walk you through some of the different steps you can take to help save for your child’s college education.
College Scholarships
A few words about college scholarships. Unless your child is athletically gifted or is the class valedictorian, their odds of getting a “full-ride” scholarship that pays for all their college expenses are rather small. This doesn’t mean they will not receive anything with partial scholarships, but, you will still have to borrow money or pull from your savings account.
National scholarship databases like FastWeb have over 1.5 million scholarships to apply for. These listings are very competitive because students from all over the country can apply and relatively few recipients. To boost your scholarship chances, try searching for programs offered by your employer, local community organizations, or their prospective schools as well.
529 College Savings Plans
Scholarships can reduce the total cost of college, but, you often do not know if your child will be awarded any until their junior or senior year of high school. Because most college students will graduate with some amount of student loan debt, it’s safe to assume that any money will set aside for college will be put to good use.
Just like you save a portion of each paycheck for retirement, it’s also a good idea to set aside a small percentage of each paycheck and place it in a 529 college savings plan. This is the most affordable way to save for college. Not only do these plans defray the cost of college, but, the contributions grow tax-free too!
How 529 College Savings Plans Work
The most popular college savings plan is the 529 plan because of their tax benefits, flexible contribution limits, and ease of making investments. Nearly every U.S. state has their own 529 plan and function similar to your workplace 401k as you have a small basket of mutual funds to invest in. Over time, the contributions earn interest and transform into a sizable nest egg just like your retirement accounts.
When your child begins attending college, they can start making withdrawals each semester to cover tuition, fees, and room & board. If there are any funds remaining after graduating from undergraduate, they can be used for a graduate degree or transferred to the 529 savings plan of your other children. Finally, education-related withdrawals are tax-free.
529 College Savings Plan Tax Benefits
There are three tax benefits for 529 college savings plans.
- Contributions grow tax-free
- Withdrawals are tax-free for education-related expenses
- Contributions may qualify for state income tax deduction
Regarding the third tax benefit, you might only qualify for the state tax deduction if you enroll in your state’s 529 plan. For example, you probably won’t be able to claim the deduction on your state tax return if you are a California resident enrolled in the Oregon 529 plan. But, if you enroll in the California plan, your contributions can be deducted.
Not having to pay capital gains tax on 529 contributions is a huge selling point for these plans. If you have to borrow money to pay for college, student loans make the total cost even more expense because they accrue interest charges each day. Even if 529 contributions will only pay for a portion of your child’s college education, it is still cheaper than borrowing the entire amount.
Choosing a 529 College Savings Plan
No two 529 plans are created equal. You will want to choose from one of the best 529 plans with the lowest costs to maximize your contributions earning potential. You are not required to enroll your own states 529 plan. This means a person living in Maine can sign-up for the Hawaii 529 plan without any consequences. If you are happy with your state’s 529 plan or reasonably certain your child will attend college in a particular state, it’s okay to enroll in that plan as well.
If you’re not sure if your child will attend college in-state or out-of-state, 529 plans can be used at nearly any school across the nation. This allows you to choose the cheapest plan and not worry about if the funds will be accepted by their future alma mater.
Making Contributions to 529 College Savings Plans
For families that plan to contribute at least $2,000 per year, the 529 plan is the best college savings account option. Unlike other education savings account options that limit contributions to $2,000 per year, most 529 plans have very high contribution limits. However, if you or a family member plans on contributing at least $14,000 in one year, that amount might be susceptible to the “gift tax” under current tax law.
Making Wise Investment Decisions
As with any investment, you will need to determine your risk tolerance. Most plans have investment portfolios that range from aggressive to conservative and have a general recommendation for which funds you should invest in depending on the age of your child. For example, it’s recommended to invest in the most aggressive option when your child is still an infant because the increased level of risk means potentially larger growth. You will gradually shift to a more conservative allocation as they prepare to finish high school and need immediate access to the funds to protect against sharp market downturns that can force you to borrow more than you have to because of being too aggressive for too long.
Coverdell Savings Accounts
A second college savings plan option is the Coverdell Education Savings Account that is often called the “Education IRA.” This account is very similar to a Roth IRA because you can invest the money however you want in any stock, bond, or mutual fund. Not just the handful of options offered in a 529 savings plan that might not perform as well as funds in your non-education brokerage accounts. The biggest drawback to this option is that you can only contribute up to $2,000 per year or $36,000 total ($2,000 for 18 years) before factoring interest, dividends, and appreciating share prices.
Earn College Credit in High School
In addition to trying to stash away money in a tax-advantaged savings account, another easy way to save money for college is to be proactive and earn college credit in high school. The general college courses most students take during their first two years are usually more in-depth classes of material they covered in high school except they cost more money. Why sit through U.S. History or Grammar & Composition a second time if you aced the course in high school, right?
By taking college-level courses in high school, your child can “double up” by earning college credit and high school credit simultaneously. This is accomplished through the Advanced Placement and Dual Enrollment courses. Plus, many school systems grade these courses on a 5-point scale instead of the traditional 4-point scale meaning an “A” is a 5.0 instead of a 4.0. The higher grade scale can boost their cumulative high school GPA and increase the likelihood of receiving a scholarship, grant, or accepted into a more selective college.
Advanced Placement
The Advanced Placement (AP) program is the most recognizable way to earn college credit in high school. Perhaps you even took an AP class during your high school years. At the end of the school year, students in the AP classes take an exam that is graded on a 5-point scale to determine if their test grade qualifies for college credit. Each college has different acceptance policies, although, you normally need to score a 4 or 5 to receive the equivalent of two college semesters (6 credits).
There are over 30 AP exams that your school district can offer ranging from U.S. History, Calculus, to Spanish. While earning college credit isn’t guaranteed, the approximate $92 for the test costs a third of an equivalent course at a public, 4-year university, these exams can easily save hundreds or thousands of dollars and allow your child to graduate early.
Dual Enrollment
Another option that has been gaining in popularity is Dual Enrollment. These courses are offered when high schools partner with a local community college or university. If your child plans to attend a public in-state college, this option is usually a more guaranteed path to earn college credit in high school while the AP program is usually ideal when attending a private college or out-of-state school because of its national recognition.
Dual Enrollment is very comparable to the AP program. There is a college-level exam administered at the end of the academic year that determines if the student understands the material sufficiently to be awarded college credit for the course or only high school credit. As each school district has different AP & Dual Enrollment options, the school might offer Dual Enrollment classes, such as Physics, that the AP program currently doesn’t offer an exam for.
Summary
Saving for college might feel like an impossible task. You might not have any trouble saving for college or your other financial obligations might only allow you to pay for the first semester and borrow for the remaining years. The important thing to remember is that saving for college isn’t an “all or nothing” proposal. Anything you save now will go a long ways to giving your child(ren) a financial head start as they prepare to enter adulthood with as little debt as possible.