Notebooks? Check. Pencils? Check. Backpack? Check. College savings plan? Yikes. Of course, we outfit our kids with essential back-to-school supplies. But, as parents, do we receive a passing grade when planning our kids' college savings?
Later in this article I'll provide three strategies to help with some of the heavy lifting, but let's first address the costs of higher education.
Diapers to a degree
Parents of a newborn need to save more than $400 every month for 18 years -- in an investment returning 8% no less -- to pay for four years of education at a public, in-state university with a current $21,447 annual price tag. When your newborn bundle of joy enters college, his or her four years will run you $222,000 (not including pizza and beer money, of course). According to the College Board, college costs have historically increased 5% to 8% annually. And they show no sign of slowing.
The only way to outpace the rising cost of college is to invest in growth-oriented securities like stocks, exchange-traded funds, or mutual funds. Let's take a closer look at a few stock ideas -- companies characterized by simple business models, stable history, and incredible brand strength. Then we'll explore three savings strategies.
Both McDonald's (NYSE: MCD ) and Coca-Cola (NYSE: KO ) have appeared on Interbrand's "Best Global Brand" list every year since 2001. The companies enjoy exceptional margins and continue to increase sales growth. McDonald's is expected to grow earnings 9% annually over the next five years, and Coca-Cola is expected to grow earnings at a 7% annual rate during the same period. Their 3.1% and 2.8% dividend yields, respectively, are a sweet bonus for shareholders.
In the most recent quarter, eBay (Nasdaq: EBAY ) boasted year-over-year quarterly earnings growth of 144%, thanks in large part to the success of its simple and trusted PayPal service. The company is expected to grow earnings at a 13% annual clip during the coming five years.
With virtually no debt, Whole Foods Market (NYSE: WFM ) has lots of room to ride the healthy-eating wave considering its abundant opportunities for international expansion. Whole Foods is expected to grow earnings 17% annually over the next five years.
Here's how you can leverage these great companies for your kid's college savings.
Money in a custodial account doesn't have to be used exclusively for college. But once you've transferred money into a custodial account, you're not allowed to take it back. When your child turns 21 (or younger, in some states), the account becomes an asset of the child. Never transfer money to a custodial account unless you are 100% sure you won't need that money later.
Coverdell education savings account
Known as education IRAs, Coverdell accounts provide significant tax benefits that custodial account don't. Even though you don't get a tax break when you contribute, earnings in the account are not taxed and may be entirely tax-free. Distributions from the account can fund education expenses from kindergarten through college.
However, tax-advantaged withdrawals on K-12 expenses and other Coverdell provisions will disappear after Dec. 31 unless extended by Congress. Currently, you can only contribute $2,000 annually per beneficiary in a Coverdell, but this annual limit will drop to $500 after year end. If you own a Coverdell account, make sure you are aware of these upcoming changes.
Charles Schwab (NYSE: SCHW ) does not charge a fee to open or maintain a Coverdell with a $1,000 account minimum. The company offers inexpensive online stock trades and free Schwab ETF online trades. And if you want to avoid the upcoming changes to Coverdell accounts, Schwab offers the ability to roll over a Coverdell into a 529 college savings plan.
529 college savings plan
Long considered the prettier sister to the less desirable Coverdell, the tax-advantaged 529 plan boasts much higher contribution limits than Coverdells. You don't pay federal or state taxes on 529 plan withdrawals as long as the money is used for qualified higher-education expenses including trade school, vocational school, junior college, and universities.
Investing in your state's sponsored plan may offer another layer of tax benefits, as many states offer tax deductions up to a certain amount on contributions to their state-sponsored 529 plans. While state-sponsored plans are a great way to go, you can generally enroll in any 529 plan regardless of where you live. You can find out about 529 plans offered in your state here.
Just keep in mind that a drawback of 529 plans is the limited pool of investment options. Also, you must wait 12 months before you can change the investment mix or transfer the money to another plan.
Save early, save often
Don't let the rising cost of college frustrate you. The worst college savings plan is the absence of one. Take action to secure your kiddo's future, and consider these three solutions today.
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