According to EducationData.org, the average cost of a four-year college education in the United States is $ 32,889. This amount has grown at an average rate of 5.2% per year over the past two decades, meaning that in 10 years at the same growth rate, students will face a cost of $ 54,600, and in 20 years, a four-year education will cost, on average, $ 90,600.
Those are startling and sobering numbers for parents everywhere. For many families, numbers like these reveal a stark choice: start saving for your young child’s education or face six-figure debts in a decade or two. That level of debt can be a lifelong burden, requiring huge payments for decades early in their career and lost opportunities that can cost them later.
What can a parent do to help? Should they save for their child’s education, and if so, how much?
Is saving for education more important than saving for your retirement?
Many parents face two opposing goals. They want to save for their retirement, but at the same time, they also want to prepare their children financially for the burdening cost of college. With a limited budget, it often comes down to a choice: do we pay for our retirement, or do we fund their education?
The best strategy is a hybrid of the two. Fund your retirement to the point that you’re on pace for a healthy retirement at retirement age, then use money beyond that to save for a child’s education. For most people, that means saving 10% of your salary for retirement, then putting any additional savings toward education.
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Why choose this approach? Ensuring that your retirement is cared for ensures that you’re very unlikely to be a financial burden on your children later in life. Not only does your retirement savings take care of you, it also takes care of your children in the sense that they won’t have to worry about you or your finances later on and can focus on their future.
Take care of the basics of your retirement savings first, then move onto saving for your children’s education.
How much should a parent save for their child’s college education?
The first step should be to assess how much of your child’s education you actually want to cover. Do you want to pay for all of it? Do you want to split it with your child? Is there a dollar amount you’ll cover, such as the tuition at a local state university, with your child having to cover the rest? There is no right answer. It comes down to what you value. Some parents want their children to understand that their education isn’t free — that it has a real cost. Other parents want their children to not have to experience any financial burdens after graduation. What matters is what you value. Give this question careful consideration as early as possible.
The single most important faction, no matter how you save, is that you start as early as possible. Start saving for college when your child is an infant, if possible. If your child is already past infancy, start immediately by saving something, no matter how small — you can adjust your savings amount later.
Why is this so important? The earlier you begin to save, the more time your savings will have to grow and thus, the less you’ll actually have to contribute overall to reach your goal.
How do you set your goal? Start by using an estimate of what a college education will cost. If you’re saving for a newborn, an average education could cost about $ 90,000 by 2040. An older child will be closer to $ 60,000 in 2030. Ask yourself what portion of that target you want to cover, and what portion they should cover for themselves. That gives you your goal.
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Then, take that goal and use an investment calculator to estimate what you need to save. Your initial investment is $ 1, your years to grow is the number of years before they begin college, and use 7% as your interest rate, compounded annually. For example, if your child is a newborn and you want to save $ 90,000 for them over the next 20 years, you’ll need to contribute $ 184 a month into something that earns a 7% return.
How to save for your child’s education
Now that you’ve determined how much you should save, the next question becomes where you should put that money. There are several great options for saving for a child’s college education. Here are four that I recommend.
Open a 529 college savings account
A 529 college savings account allows you to save for your child’s educational needs without incurring taxes on the investment gains. In some states, they offer additional tax benefits, allowing you to deduct contributions from your taxes. Using a 529 plan is easy once you know the basics. Within a 529, you can choose from a variety of investments, though most accounts offer a straightforward target investment plan that optimizes investments for you based on a high school graduation date. Using a 529 when it’s college time is easy, too; your college or university will work directly with the plan. A 529 is the best all-around option for most people.
Open a Coverdell
A Coverdell education savings account is similar to a 529, but with a few key differences. Unlike a 529, each person who contributes to a Coverdell is restricted to $ 2,000 in contributions per year, though you can contribute $ 2,000 a year to a Coverdell and additional amounts to a 529 in the same year. Also, you can’t use a Coverdell if you earn over $ 220,000 a year as a married couple or $ 110,000 a year if single. However, a Coverdell gives you much more control over your investments. If you like to study investment options and optimize your plans, this may be a good choice for you.
[ Read: The Guide to the FAFSA ]
Use an ordinary investment account
One disadvantage of both the 529 and the Coverdell is that if your child ends up not needing the money for educational expenses, there’s a tax penalty for non-educational withdrawals from the account. Using an ordinary investment account gets around this — you have to pay taxes on all investment gains, but you don’t have to pay an additional tax penalty if the money isn’t used for educational purposes.
This is a good option if you want to be able to hedge your bets down the line, but it comes with a big disadvantage. If your student is applying for more financial aid using the FAFSA, assets in an ordinary investment account will have a negative impact on the student loans and grants they’ll be able to get. This means that they may have to rely more on private student loans, which may have higher interest rates and stricter requirements.
Use a Roth IRA
Yet another option is to use a Roth IRA for educational savings if you’re not already using one for retirement savings for yourself. In this case, you’d open a Roth IRA in your name and make annual contributions to it. When your child is ready for college, you can then withdraw your contributions without penalty and use that money to help pay for college. If you contribute $ 5,000 a year starting at birth, that adds up to $ 90,000 in contributions by the time your child is going to college. The extra money earned would stay within the account and bolster your own retirement savings, though it won’t be enough on its own to sustain you. This should be used in addition to other retirement savings vehicles like a 401(k). Consider this option if retirement savings is a big concern for you.
Too long, didn’t read?
College education is expensive, and for many parents, it’s a major lifetime financial goal to help their children with college expenses. The most important principles to follow are to start as early as you can and to make sure you’re not letting down your own retirement savings. For most people, a 529 college savings plan is the best way to save.
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