Saving for College 101

Alden Wicker
Posted

One of the biggest money worries parents have today?

“How on earth will I pay for college?”

It seems like a daunting task. You want the best education possible for your child, but current college tuition seems like a lot to put away. And with experts predicting that college 18 years from now will cost $361,000 for four years at a private university and $100,000 at a state school, how can you keep up with tuition inflation?

The answer lies in college savings accounts, which provide a place to grow your money quickly and safely, so by the time your wee one is applying to college, you’ll be able to cover a significant portion of their expenses, if not all of them.

College Savings Accounts in a Nutshell

College savings accounts are investment accounts that give you a way to save tax-free for higher education costs. These plans have two key players: the plan’s owner (in this case, you) and its beneficiary (your child). As the owner, you will receive whatever state tax benefits are available for contributions (there are no federal tax benefits for such savings plans), while the beneficiary of your plan will get to use the funds.

It’s important to note that these are investment accounts, not traditional savings accounts. You want your money to grow, and at a faster pace than inflation, which is around 3% a year on average. (And college tuitions are rising at around 6% a year–and some at almost 8%!) If you tried saving up for your child’s education in a traditional savings account, which as of August 2012 earns only 1% in interest at the most, by the time your child is ready to go to college, your money would actually be worth less than when you put it in there!

Investment accounts get around this problem by growing at roughly the pace of the market. Based on historical averages, you can assume that it will grow at around 7% a year, depending on the investments you choose. So by the time your child is ready to cash it out, you will likely have more in there than what you put in.

Saving for College 101

Why Parents Need to Understand College Savings Accounts

There are two main reasons you, as a parent, need to understand college savings accounts:

1. Because college is important for your child.

If you want your child to have all the opportunities you had and more (who doesn’t?), then college is the one proven way to make that happen. Children born at the bottom rung of the economic ladder who go to college are more than three times more likely to rise to the top than children in the same socioeconomic class who don’t go. A degree also makes people raised in a middle or higher economic group significantly less likely to lose ground. In other words, while growing up in an upper-middle-class household helps your child’s odds of staying relatively wealthy as an adult, having a college degree will likely ensure a secure future.

2. Because, if you save for college in advance, you’ll pay less overall.

You might be hoping that once your child gets within reach of college, you can fund his or her education with a combination of loans, grants and scholarships. But according to FinAid.org, gift aid from the government, colleges and universities and private scholarships pays for only about a third of total college costs.

You could have your child take on student loans to pay for the rest, but this is much more expensive. FinAid.org estimates that if, in the years before your child enrolls in college, you save $200 a month for ten years at 7% interest, your child would then have $34,819 to use. But if you borrow the same amount at 6.8% interest and pay it back over ten years, you’ll be making payments of $401 a month.

There’s also no guarantee your student or you will be able to pay it off, especially since students loans have become an untenable burden for graduating students. Nearly three in ten student loans are currently in default. You cannot discharge student loan debt in bankruptcy. And middle-aged Americans are among the people struggling the most with student loans right now–because they took out loans beyond their means to finance their kids’ education.

  • Ashley

    I don’t know where they got their information, but loans and grants covered more than twice the actual cost of college.

    Kids pay for their own schooling. Period. I did and so will my kids. They don’t appreciate their education if you pay for it. I don’t know why parents stress about this. There are so many more important things to stress about.

    And the more assets you have saved up, the more the government expects you to contribute and vice versa. Against popular realization, it pays to NOT save for college.

    Kids look for a good school, that is affordable. Not go to a private college then become a stay at home mom with a $1500/month loan payment. I knew what my payment would be before graduating. Coming from a person that went to school for 6 years and paid her way, this is not the way to deal with college expenses. Do not save for college. Use grants and loans. DUH.