By Samuel Greengard | American Express Credit Intel Freelance Contributor
7 Min Read | May 11, 2020 in Money
It doesn’t take an advanced degree in economics to know that college costs have skyrocketed for many years. How much you save for college can determine where your child goes to school and the types of experiences he or she may participate in as a college student. Plus, graduating without loans that take years to repay can help young grads buy a home and tackle other major life expenses sooner than they otherwise could. It might also allow them to further their education or travel the world after completing their undergraduate degree.
Here are five ways to make saving for college more manageable:
According to the College Board, a not-for-profit organization that promotes higher learning, the total cost of attending a four-year public university in the U.S. now averages $21,950 annually. Average total charges for out-of-state students in 2019-20 have climbed to $38,330.1
If your child is young, you will likely have 15 to 18 years to save for college. Of course, it’s likely to be more expensive by then—though the rate of cost increases has slowed in recent years. The College Board reports that 5% annual increases between 1999 and 2010 have slowed to 2.2%, before inflation is taken into account. But it also cautions that incomes have lagged behind higher college costs.
Many people focus on annual costs rather than the total cost of obtaining a bachelor’s degree, which may require more than four years.2 So what steps can you take? Use online calculators or consult with a financial planner to map out how much you need to save if you’re aiming to provide half, more, or all of the funds required. Finally, understand that any approach must be flexible. For more about college costs, read, “Guide for Parents: How College Students Spend Money."
The cost of attending college is merely a starting point for creating a savings plan. It’s also important to understand your situation. For example, many younger families with small children have high expenses. Meanwhile, their careers are just getting started, making it harder to save for college. Fast forward a few years, and they may be more established in their careers and have seen their earnings rise. If this sounds familiar, consider starting with modest contributions for college savings and then step up contributions every year or two.
Also, consider having the savings deducted automatically and asking family members to contribute to the college fund instead of buying gifts for baby showers and birthdays. Some states have web sites that allow family and friends to contribute to qualified college savings accounts.3 Regardless of the approach you take, don’t neglect funding your retirement. Contribute to both college and retirement funds, even if it means half as much for each. Otherwise, you may find yourself in a precarious financial position just as your child is graduating from college.
These plans4—which derive their name from section 529 of the Internal Revenue Code5—can turbocharge college savings. One of the biggest advantages is that any money you contribute to the account up to the annual limit isn’t subject to federal income tax (and some states offer tax breaks as well).6 When you withdraw funds, you’re able to use them for all qualified educational expenses, including tuition, fees, equipment, and room and board.
There are two basic types of 529 plans: prepaid plans that allow you to purchase tuition at today’s rate for future use; and savings plans that allow you to invest in mutual funds and other investment options. Pay attention to the specifics of a plan. Fees and investment options vary significantly.7 Contrary to popular belief, a 529 plan will not reduce your odds of obtaining financial aid, though it may slightly reduce the amount of aid you receive.8 Also, know that you can change the beneficiary to another child, if you have funds remaining after your first child completes school.
Despite the advantages, recognize that there are also potential drawbacks to 529 plans. One of the biggest is that any money that’s not spent on educational expenses is subject to taxes and a 10% penalty.9 Also be aware that there are other types of savings plans suitable for college, including a Coverdell Education Savings Account (ESA)10 and a Uniform Gift to Minors Act (UTMA) account.11
To show how different investment styles can affect a family’s total savings for college, let’s look at a hypothetical example: Over the course of 18 years, Family A and Family B each save $200 per month for college. Family A plays it safe by using low-risk, low-return investments, while Family B takes a greater risk by investing in mutual funds. Mutual funds typically offer higher returns, but the value of the account could have dropped significantly during a market downturn. As a result, Family A barely makes a 2% return while Family B gets 7%. So, Family A winds up with just over $52,300 in their fund after 18 years, while Family B has more than $87,300.
The moral of this story? It’s important to gauge your risk tolerance and avoid overly conservative or extremely risky investments. Of course, as your child approaches college, it’s wise to shift some or all of the funds into “safe” assets, like a money market fund or other cash position.
Saving for college requires discipline. Some see that discipline, and the sacrifice it sometimes requires, as difficult—a mountain they’d rather not climb. But for others, the potential achievement—seeing your college fund rise higher than you thought possible thanks to cutting down on coffee shop spending and dining out—can feel empowering. Like you conquered that mountain! So, if you started saving late in the game, consider scaling back vacations for a few years or keeping a car a bit longer. If you need to trim household expenses, hold a family pow-wow and discuss why you’re cutting back. Also, consider asking your child to contribute money from a job so that he or she has more of a stake.
It may be possible to save on expenses by selecting an in-state public university rather than an out-of-state or private school. Likewise, attending a community college for a year or two and living at home before transferring to a four-year university can stretch a fund considerably. Along the way, don’t overlook scholarships,12 grants, and financial aid. Finally, don’t stress yourself out if you can’t cover 100% of the costs. Meeting 75% or even 50% of your child’s college costs is still an incredible gift.
With the right planning and a positive but realistic approach, your saving-for-college program can build a valuable fund for your child’s future. The key is to understand your situation, save, invest wisely, and make realistic choices. Those who adopt a balanced approach will find their college savings plan makes the grade.
1 Trends in College Pricing 2019, College Board
4 “An Introduction to 529 Plans,” U.S. Securities and Exchange Commission
5 “IRS offers guidance on recent 529 education savings plan changes,” Internal Revenue Service
6 “State tax deduction or credit for contributions,” SavingforCollege.com
7 “What should I know before investing in a 529 savings plan?,” Consumer Financial Protection Bureau
9 “How to Save for Your Child’s College Expenses,” IGG Software
10 “Topic No. 310 Coverdell Education Savings Accounts,” Internal Revenue Service
11 “Uniform Transfers to Minors Act (UTMA),” Investopedia
12 “Scholarships,” FinAid