If you’re like a lot of Americans, you probably dream of the day that you’ll be able to help your children with their college costs. Most of us know the pain of graduating college with thousands of student loan debt to our name. We hope and dream that we will be able to do something about it so our kids have a debt-free start after college. However, most of us don’t even know where to begin when it comes to starting a college fund for our children. It feels overwhelming and too far fetched of an idea.
But, it is possible. You can start putting money back each year towards your children’s tuition and college living expenses. All you need is a plan and several tools to help you along the way. The first thing to understand is the perfect time to start saving — that time is now. Today. Don’t put off planning any longer. The sooner you start, the more you’ll be able to do for your child.
There are a lot of tools available for parents to get started with the planning process. For instance, John Hancock offers a college planning calculator. You can input a few factors to help determine if you’re saving enough or not. You need to know:
- Your child’s current age
- Number of years you would like to help pay for
- How much you are able to put aside each month
- The percentage of cost you want to fund
You can even select which college your child might attend to get a more accurate estimation. There is quite a bit of difference in costs between public university and private schools. On average, college costs increase at a more rapid pace than inflation. According to College Board, Trends in College Pricing 2016, college inflation rate is typically in the range of 3% to 6% for both private and public colleges.
The John Hancock calculator will illustrate if you are going to save enough to fully fund what you would like or if you’re underfunded, and by how much. You can tweak the amount you are saving each month to see how much you should be putting aside to meet your goal. It’s a great tool for parents to see how much they should be putting back and when they should start planning.
Once you know how much to be saving each month, how do you know what type of investment vehicle to use?
The first option, and probably most popular, is the 529 plan. This plan allows you to invest after-tax dollars. They offer tax-deferred growth and any distributions used for qualified education expenses are federal income tax-free. These qualified expenses include items like tuition, fees, books, room and board, and any other required items for degree seekers.
Uniform Gift/Transfer to Minor Act (UGMA/UTMA)
Another college savings plan is called the Uniform Gift/Transfer to Minor Act (UGMA/UTMA) accounts. Part or all of the earnings are exempt from federal income tax and some or all may be taxed at the child’s rate which is generally lower. When an investment held by a child generates income in excess of the IRS threshold then the “kiddie tax” takes effect and part of the child’s unearned income over the threshold amount could be taxed at the parent’s rate. The “kiddie tax” rules apply to dependent full-time students under age 24. These accounts are tricky when it comes to taxes so it’s best to talk to a financial advisor or tax expert before moving forward.
An adult acts as the custodian of the UGMA/UTMA accounts until the child is no longer minor. At age 18 through 21, depending on the state, the child owns and gains control of the account, which may not be your wish. These accounts are typically costly to the student in the financial aid equation.
There are other options available such as the Coverdell ESAs (Education Savings Account), which allows contributions of up to $2,000 a year per child for education (college or K-12) expenses. Earnings grow federally tax-free, and qualified distributions are federal income tax-free. Income limitations do apply though.
Parents can also set up a Roth IRA under their name or even create a non-retirement mutual fund account. However, it’s recommended before starting any investment to speak with an investment advisor or financial planner. They will be able to discuss your current situation to gauge which type of investment best fits your needs.
The biggest lesson when it comes to saving for future college expenses it’s to start today. Even if it’s a smaller monthly investment, getting started is key. Scholarships and financial aid are not promised to everyone and you never know what educational aid changes are going to be passed. The best solution for relieving that college debt you’re probably familiar with is by making strides to help your children.