School may be out for kids, but it's time for us parents to sharpen our pencils. Do you receive a passing grade in planning and saving for your child's college education? Here are five personal finance tips to help you get an "A."
1. Develop your goal
The process starts with understanding your expectations for funding your kid's education. That involves getting familiar with the potential costs of a college education. Four years at a public in-state university costs nearly $86,000 today, according to The College Board. In 18 years, that'll run closer to $222,000, assuming a 5% average annual college inflation rate. To work toward covering those rising costs, it's important to come up with a plan.
Your strategy should include how much of your child's education you'd like to pay. Maybe that means footing the entire bill, half the cost, or tuition only. Make sure your strategy takes into account how much money you can afford to contribute after accounting for your own cash flow and retirement savings goals. While you can't control the level of scholarships, grants, or loans your child will receive, you can control the amount you save for education. The more money you've saved and invested for college, the more control you'll have in figuring out how to fund it.
2. Know your options
There are many ways to save for education. The most popular savings accounts include the 529 college savings plan, the Coverdell education savings plan, and the custodial account. Your individual goals and circumstances will help determine which option is most appropriate for you. For example, if saving on a tax-advantaged basis is important to you, then the 529 or Coverdell will be your best bets. That's because amounts deposited in both types of accounts grow tax-free until they're distributed, so long as the money is used for qualified education expenses.
If you want to contribute more than $2,000 annually, the Coverdell won't cut it, because that's the annual contribution limit for that type of education savings account. With a 529 plan, you can contribute "the amount necessary to provide for the qualified education expenses of the beneficiary" -- but there may be gift tax consequences if your contributions to a particular beneficiary exceed $14,000 during the year..
And if you prefer that the assets be considered yours (as the parent) indefinitely, then a custodial account doesn't make sense: Your child is the sole owner of the account, and once the child reaches age of majority, he or she owns those assets solely and outright.
Make sure you know the specifics before opening and funding an account.
3. Start saving early
It's never too soon to start saving for college. Just like cramming for a big test at the last minute isn't a smart idea, delaying saving for college until your child is a teenager isn't advisable either. The longer you have to save, the more you can take advantage of compounding growth, reinvesting dividends and interest so they, too, can earn dividends and interest. Time is your biggest asset, so start early, even if that means saving only a small sum each month.
For example, parents of a newborn would need to save $430 per month to completely cover the cost of the average four-year public university's in-state tuition, assuming 5% annual college cost inflation and an annual return on investment of 7%. By comparison, those same parents would have to fork over $546 monthly if they delayed saving until the child was a kindergartener and a staggering $1,015 per month if they waited until their bundle of joy was a teenager.
4. Stay on track
Once you've developed a strategy and determined the best account for your needs, explore the options for systematic investing. That means investing a specific amount of money on a regular basis into the plan. Even better, setting up an automatic monthly payment is an easy, proactive, and foolproof way to build a nest egg for your child's education.
5. Increase contributions
Look for ways to boost your contributions to the plan. For example, dual-income parents typically spend hundreds of dollars each month on child care from the years between maternity leave and when the child enters kindergarten. When your kid starts kindergarten, parlay that monthly dollar amount into your child's college savings account. You won't miss the money, because you're already spending it. Or if you receive a salary bump, increase your kid's education savings account with part, or the entire amount, of your raise.
Your child will be a dorm dweller in the blink of an eye. College is right around the corner, so leverage these personal finance tips and start saving today.