Here’s a news flash…college is expensive. No big surprise, right? But what is surprising is how few families with children under the age of 18 are currently saving money for college. Approximately half are setting aside money in a dedicated account for their children, but most are saving less than $16,000 overall. Even at today’s tuition rates, that’s not going to cover very much. Now, here’s the really scary part. Families with newborns can expect to pay more than $442,000 for a 4-year undergraduate degree when their children graduate from high school, if tuition continues to increase at a rate of 7% per year. That means, families would need to set aside approximately $875 every month in a college savings plan to help their children graduate with as little debt as possible. For many families that may not be feasible, but any amount saved would be better than nothing at all. Of course, the earlier families start planning and saving for college the better. That’s why this week’s post will be dedicated to reviewing some of the available college saving options for parents, as well as some other less conventional methods families can use to set aside money to help their children pay for college.
College Savings Accounts
There are two types of 529 Plans available. The first one, a pre-paid tuition plan, allows parents to lock in today’s college tuition rates at in-state public colleges (some may be converted for use at private or out-of-state schools). Essentially, parents are buying tuition credits that can be used in the future (5, 10, or even 20 years from now) and most plans are guaranteed by the state’s government, so there’s little to no risk. There are also pre-paid tuition plan available for private colleges.
The second type of 529 Plan is a college savings plan. With this type of account, parents invest in mutual funds or other similar types of investments. The money in the account will fluctuate, depending on the market. The upside is that parents can invest in plans outside of their home state and can use the funds at any college. Nearly every state has a 529 Plan, so parents should research the available options and compare features to determine which may be the best fit for their families.
Coverdell Education Savings Account
Formerly known as the Education IRA, the Coverdell Education Savings Account allows parents to save for educational expenses with tax-deferred growth, offers more investment flexibility than a 529 Plan, and typically has lower operating costs. Parents may contribute up to $2,000 per year, if they meet the income eligibility requirements. Accounts may be set up for any child under the age of 18 and may be opened at any U.S. bank.
The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) are custodial accounts that are set up by parents (or another adult) on behalf of a child. Unlike the Coverdell Education Savings Account, there is no annual contribution limit, but parents should be aware that a custodial account may actually affect a child’s eligibility for federal financial aid because the account will be in the child’s name. That also means when the child reaches the age of consent (18 to 21), he or she will have full control of the money including how it is spent.
Other College Saving Options
U.S. Savings Bonds
There are two types of savings bonds that are better suited for college savings: Series EE and Series I. Both offer a reliable, low-risk way to save for college that is backed by the government. Series EE and Series I bonds may be purchased online in any amount between $25 and $10,000 (the maximum annual limit) each. Parents can also purchase Series I bonds with their IRS tax refund. Interest (currently .10%) is earned monthly and compounded semi-annually.
According to a recent Wall Street Journal article, 19% of parents who are saving for college plan to tap into their life insurance policies to help pay for it. This is often seen as a less risky investment than a 529 Plan, but in order for parents to see any return, they must keep the policy active for eight or more years. One of the most attractive benefits is that parents’ life insurance policies are not counted as an asset on the FAFSA, which means it won’t affect the aid that their children may be eligible to receive. Whole life insurance policies are also popular because insurers guarantee a minimum return.
Parents can also save money for college by shopping or dining out. There are credit cards available that offer the ability for parents to transfer earned reward dollars into a 529 Plan or another savings account. Other services, such as UPromise and SaverNation, also give parents the ability to use several cards to earn cash rewards for college savings or retirement accounts. It’s a great way to double-up rewards when using a linked credit card that also provides a cash-back feature. Savvy shoppers can also take advantage of many of the available saving apps to earn even more money back for their everyday purchases. Over time, these savings can add up and help pay for many college expenses.
Parents should be smart when it comes to saving for college and use the team approach. Grandparents and other relatives can help by purchasing savings bonds or even using special UPromise coupons while shopping at the grocery store or other retailers. It’s also a good idea for parents to encourage their children to start applying for scholarships as early as possible. When everyone works together to reach a savings goal, the likelihood of success dramatically increases.