By Ann Lloyd, Student Savings Guide
If you’re planning for your child’s future education, the picture can seem daunting. Between 1985-86 and the 2017-18 academic year, the cost of attending a four-year university or college rose a staggering 497%, which was more than twice the rate of inflation.
That has made saving for college a lot more challenging than saving for retirement – where you can get help from 401(k) accounts – or just the plain old rainy day.
It’s hard to even estimate how much college will cost a few years from now, so the sooner you start saving, the better. But how much you can save will depend on your budget, as well as your and your child’s goals for college.
No matter what your budget, however, there are ways to save that can help your kids make it through with a minimum of student loan debt hanging over their heads for years down the line.
And that’s a real concern: What good is landing a good-paying job if a lot of your paycheck is going to student loans, and if you’re still paying later in life? While fewer people in their fifties are paying on student loans, those who are doing so have significant balances: an average of more than $42,000 for those in the 50-61 age bracket.
Gifts and loans
If your child racks up significant student loan debt, it can be tempting for you, the parent, to step in and help. But you may not have money in the bank to do so. One option is to take out a loan to help. If you decide to go this route, you’ll need to have good credit, and that’s something that will take time to build.
Check your credit report, resolve any late payments, dispute any errors, reduce your debt, and be sure to make future payments on time. Be aware, also, taking out a loan to pay off a loan may not be a good idea if your terms are worse than those on the loan you’re replacing.
If, on the other hand, you do have money to make a gift to your child, be aware of the tax ramifications. if you pay more than $15,000 a year, you’ll trigger a federal gift tax (although you can gift an extra $15,000 a year to your child’s spouse, if they have one).
Set up a 529 plan
A 529 plan is a state-run plan to help pay for education, which can apply to higher education or K-12 students.
You can choose from a prepaid tuition plan or a savings plan, which is more common. You contribute money to a savings plan and can choose how it’s invested. It can then be withdrawn to cover educational expenses, such as tuition, room and board, etc. Up to $10,000 can also be withdrawn to cover the cost of student loan repayment.
Under a prepaid tuition plan, you lock in current interest rates for children who’ll be attending years later, when rates will theoretically be higher. It just covers tuition, though.
The earnings from 529 plans aren’t subject to state or federal taxes — unless you use them for something other than education, which will trigger a 10% penalty. Plus, the money you contribute to these accounts is not tax-deductible. So, if you’re not sure whether your child will go to college, this may not be the best option for you.
Put money into a savings account
Putting money into savings is perhaps the most straightforward and traditional way of saving for college. On the positive side, it’s a low-risk move, especially if your bank and account are FDIC insured.
It also offers you some flexibility, because you’ll be able to use the money anywhere: at a community college, a four-year university, or elsewhere if your child decides to forgo college altogether. Money is money, and it can be used as a down payment for a house, moving expenses to relocate for a good job, or anything else in the long run.
Another upside of a savings account is that it can involve your kids by opening a joint savings account with them, teaching them the value of saving.
The downside is that savings accounts earn modest interest: The highest rate available carries an annual percentage rate of 0.7%, which is less than the rate of inflation, even in most good years. Here’s a list of the best high-yield savings accounts in 2021.
Purchase savings bonds
Bonds are another old-school way of saving for college. Back during World War II, Americans were urged to buy bonds in support of the war effort. Many patriotic citizens did just that, and put them away for their kids or grandkids to use on college tuition.
Of course, tuition was a lot cheaper then, and bonds have fallen down the list of ways to save since then. Still, they are an option that’s available to you as long-term investments. You buy them at less than face value; then they generate interest over the next 15 to 30 years, at which point they can be redeemed for their full value. Before that, you’ll get less; afterward, they stop earning interest, so there’s no point in holding on to them.
A 30-year Treasury bill, like an FDIC-insured savings account, is secure because it’s backed by the government. Also like savings accounts, however, government bonds are not high-yield options and may not earn the kind of interest you need to send your child to college.
Pull money from your Roth IRA
Roth IRAs are meant for retirement, but you can withdraw the principal at any time for any reason — including your child’s education. You can’t, however, touch the interest you’ve earned without incurring a penalty before you’re 59½.
Also worth considering: The more you pull from your principal, the less you’ll be earning for your retirement, so you should either be comfortable with what you’ll have left or have an alternative plan to make up for it.
Certificates of deposit are another way you can save for your child’s education. When you buy one from a bank, you give that bank the right to use your money for a specific period of time. In return, the bank pays interest.
CD interest rates are generally a little better than those paid by savings accounts. And like savings accounts, they’re safe if they’re purchased through a federally insured bank.
These are some of the many options you have when it comes to saving for your child’s future education. If you’re unsure which works best for you (you can always employ a combination), consult with a financial advisor to come up with a plan that makes sense.