Saving for College 101

Alden Wicker
Posted

The solution is to start saving in a college savings plan before your child goes off to college.

The Types of College Savings Accounts

There are three main kinds of college savings accounts you need to know:

529 College Savings Investment Plans

A 529 Savings Plan—named for the section of the Internal Revenue Code that created it—is a type of investment account provided by your state that allows you to save for your child’s college education, tax- and penalty-free. Some key characteristics:

  • It’s available to you regardless of your income level.
  • You can use the funds to pay specifically for your child’s college-related expenses, including tuition, fees, room and board, books, supplies and equipment.
  • If you use the money on anything else, you will be subject to heavy penalty fees of up to 10% on the earnings, plus you’ll have to pay federal income taxes on the earnings. Additionally some states might even include an additional 10% penalty for early withdrawal.
  • It varies by state, but contribution limits are high, up to $360,000 total. But if you contribute more than $13,000 a year, your contribution will be treated as a gift and taxed. (A married couple can donate $26,000 per beneficiary.) Or, you can contribute five years’ worth of “gifts” in one year ($65,000 for an individual or $130,000 if you’re married), and not incur a gift tax as long as you don’t contribute anything else for the next four years.

Prepaid Plans

A prepaid plan is a form of a 529 that is becoming less common, and it probably makes sense for you if you believe your child will attend an in-state public college. The differences are:

  • You’ll get a locked-in price at the current average rate of tuition at state public schools (though some states will charge you extra for the privilege), and if your child actually does go to an in-state public college, the plan will pay for tuition and required fees based on the average public university rate in your state.
  • If your child decides to attend a private or out-of-state college, this type of plan would typically pay the average in-state public college tuition, and you will be responsible for any difference in price.
  • Most prepaid plans can’t be used to cover other expenses associated with school, such as room and board, without penalties.

Coverdell Plans

A Coverdell account differs from a 529 investment plan in that:

  • Only $2,000 a year total can be contributed, whether the full $2,000 comes from you or $1,000 comes from you and $1,000 from a grandparent.
  • You can use the money in the plan for qualified primary and secondary education expenses.
  • You can’t contribute if your income is more than $110,000 singly or $220,000 if you file taxes jointly with your spouse.
  • You manage the investments yourself instead of handing them over to an investment manager.

Given these limitations, you should probably only choose a Coverdell if you would like to use it to pay for private K-12 education for your child as well. You also have the option of opening a Coverdell in addition to a 529 plan and contributing to both.

Your Questions About Savings Plans, Answered

1. How should I prioritize saving for college over other financial priorities?

You should always max out your retirement account first before putting money toward your child’s 529. This is for two reasons:

  1. Your child can always apply for financial aid, but there is no assistance or loans for retirement.
  2. You can always take money out of your retirement account to pay for your child’s college, although you’ll most likely pay hefty penalties to do so.

2. When should I start investing?

As soon as possible. As with all kinds of investing, one of the key ingredients to making your money grow is time. Because of the power of compounding interest, starting just a few years earlier could make a difference of tens of thousands.

3. What if I open an account and my child doesn’t go college?

You’re allowed to change the beneficiary of a 529, usually at least once a year, as long as it’s to another family member–to Child No. 2, for example, or even yourself! (If you decide you want to use the funds for your own education, whether for a bachelor’s, master’s or higher degree, you just need to change the beneficiary to yourself.) Most policies also allow you to roll over the amount in your 529 to another 529 plan.

4. Will my 529 plan affect my child’s chances for financial aid?

Yes, but only slightly. If the 529 plan is owned by a parent (as opposed to, say, a grandparent), up to 5.6% of assets in that plan will be assessed for financial needs.

How Much Should You Save?

If you’re ready to get started saving, use this calculator to determine how much you need to save each month to get to your college savings goal. Or, you can play with the numbers to see how much you’ll be able to save with what you have available in your budget next month. Once you’ve figured it out, go into the Money Center and set up a Priority Goal to start putting that money away.

Remember …

With the right planning, you can send your child to a high-quality college that will set them up for success. But don’t put aside your retirement goals to save for college–your child will feel the stress and burden too if you get to retirement age and you don’t have the financial means to support yourself!

  • 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.