Given the exorbitant price tag attached to many colleges today, many families struggle to fund an education. In fact, 65% of parents say they're worried about having enough money to help pay for their kids to go to college, according to a just-released survey from Discover Student Loans.
In fact, only 41% of parents are planning to use savings to pay for their child's higher education. And just 28% of parents surveyed this year say they'll manage to cover the entire cost of college.
If your goal is to put a child (or two, or three) through college, then it's imperative that you save early on, but also save efficiently. If you don't, there's a good chance your child will wind up graduating with a pile of student debt -- or that you'll end up in debt yourself in an effort to help your child obtain a degree.
The smart way to save for college
The earlier you start socking away funds for college, the greater your chances of managing to cover those costs down the line. In fact, it's not a bad idea to start saving for that milestone as soon as your children are born or shortly thereafter. It may seem borderline ridiculous, but think about it this way: Assuming your child goes to college straight out of high school, you only have an 18-year window to put money away for it, so the sooner you start, the more opportunity you'll have to accumulate a decent education fund.
Imagine you start saving $300 a month for college when your child is eight years old. You might think you're golden, what with that 10-year window. But if you invest your savings at an average annual 7% return (which is a reasonable assumption for an investment window of a decade or longer and a stock-heavy portfolio), you'll only wind up with about $50,000. Meanwhile, for the 2018-2019 academic year, the average cost of tuition, room and board, and fees for a public, four-year in-state school was $21,370 -- which means that while $50,000 would do a decent job of covering some of that total expense, you'd fall short over the course of four years.
On the other hand, if you start saving that $300 a month when your child turns one, you'll wind up with $111,000. And that leaves you with more than enough money to pay for four years of in-state college at its current rate. (Keep in mind that college tuition rates can climb substantially from year to year. The point, however, is to illustrate that saving for college when your children are young is your best bet.)
Now let's talk about where to house your college fund. You could stick to the bank, but if you do, you won't see a 7% return on your money. On the other hand, if you put your savings in a 529 plan, you'll have an opportunity to invest that money and also reap some tax benefits down the line.
A 529 is an educational savings plan sponsored by individual states. The money you contribute goes in after taxes, so there's no immediate tax break involved. Your investments in that account, however, get to grow tax-free, which means you won't pay taxes on your gains as long as you use those funds for education purposes.
You can choose to invest in any state's 529 plan; you're not limited to your home state's plan. And 529 plans give you the flexibility to change beneficiaries so that if, for example, your first child gets a scholarship, leaving you with excess funds in his or her account, you can designate a younger sibling as a beneficiary instead without penalty. In fact, the only time you'll pay a penalty on a 529 plan is if you withdraw funds for non-education purposes. In that case, you'll lose 10% of the amount you withdraw, but only from the gains portion -- not from your principal contributions.
Another thing to keep in mind is that some states offer tax incentives to contribute to a 529. Therefore, while you won't get a federal tax break for funding one, depending on where you live, you might eke out some additional savings.
The cost of college isn't expected to drop drastically anytime soon. If your goal is to cover most or all of that expense, start saving for it as early on as you can and save smartly. A 529 plan isn't your only college savings option, but it's a smart one to consider.