The sooner you get started on reviewing the types of college savings accounts, the better!
If you have kids, then you should start thinking about college. After all more than 50% of school age students will attend college according to the National Center for Education Statistics. But if you have reviewed types of college savings accounts, you may be confused!
And when we get confused, we sometimes get stuck in analysis paralysis!
Encouraging your kids to attend college is a good thing! On average, students with a college degree earn 66% more than those with just a high school diploma or GED (also according to the NCES).
SallieMae recently published its How America Saves for College 2016 study. They found about 57% of Americans are currently saving for their kid’s college fund; an improvement over prior years. They also noted an average college fund of about $16,000.
Why should you save for a college fund?
Trust me; you don’t want your kids to get to age 18 and then suddenly wonder where the money is going to come from!
Since we know from that it costs a minimum of about $18,000 for a 4 year degree from a public college (according to the National Center for Education Statistics), you don’t want to leave that to chance!
Choosing one of the types of college savings accounts now is your BEST option.
You also don’t want to saddle yourself or kids with student loan debt! That’s been a major news story for years now and for good reason!
According to Debt.org the average college student carries over $34,000 in student loan debt! When you consider that (again going back to the NCES for statistics) the average college graduate comes out earning just under $50,000/year; that’s a lot of debt to pay off!
— Walden Publishing (@W__Publishing) February 25, 2017
When should start to save for your children’s college fund?
Ideally you would start your child’s college fund anytime up to age 5. After all, the longer you have to save, the more interest you will grow. But if you waited until they were older, it’s not too late!
Saving ANYTHING is better than saving nothing.
When you choose from one of the types of college savings accounts, you’ll likely (and I get more into this below) choose a 529 plan.
Essentially this is a Roth IRA for your child’s education. If you don’t understand what I mean when I say Roth IRA don’t worry! It’s really not rocket science and information is your friend.
I covered a lot about investment options in a previous post about Powerful Investing Tips for Beginners. So I highly recommend you take a moment and review those since there is a lot of overlap here.
How much do you need in your college fund in total?
The best way is just to do the math.
So first you need to figure out where your kid(s) plan to go to college. If they’re young (hopefully), they won’t have a clue.
We know in-state tuition is much cheaper than going out of state. We also know doing 2 years at the local community college first makes it even cheaper.
You can also decide if you want to pay for all or a portion of their college.
Maybe you cover tuition while they work part-time and pay for their books and living expenses?
If they go local, obviously they can save money by living at home. Since we know some averages that I mentioned above, you can safely assume somewhere between $18,000 to $40,000; a wide spread I know! And if you’re thinking Ivy League, you’ll obviously need to go WAY up.
CollegeBoard.org has a great Average Published Undergraduate Charges chart for showing a number of different college options and their current prices.
Check out and click for more info:
The 2nd major factor is how old they are now. Obviously I don’t know the answer for all of you, but for math purposes, let’s say your kid is 5 and they will go the community college and local route so they’ll need at least $18,000.
What amount should you save every month in your college fund?
Make a plan 2 start saving for your children’s college. Even if it’s a small amount something is better than nothing pic.twitter.com/ump0x6hu5s
— Bella Undaunted (@BellaUndaunted) September 28, 2016
Using this compound interest calculator from MoneySavingPro, I plugged in saving $60/month at age 5. I estimated 10% interest per year, compounded over 13 years.
Believe it or not, but that small amount of money covers an $18,000 bill!
Of course, the interest rate will vary depending on how you invest your 529 plan and markets can fluctuate over those 13 years. Nothing is guaranteed. Save a little more as a cushion if you wish or save a little less if you think your needs will be smaller, but this IS doable!
Lastly, you need to know that according to Finaid.org, the cost of college goes up every year at roughly TWICE the rate of inflation!
Thus you can assume college will continue to go up at least 2% per year! Check out Finaid’s awesome College Cost Projector calculator to project your own college fund needs!
What are the best types of college savings accounts?
— CSPN (@College_Savings) February 22, 2017
I’ve now mentioned the 529 plan a couple of times.That is the exact college fund plan I use for my 2 daughters.
I personally believe this is the best option of the types of college savings accounts.
Going back to that SallieMae study I referenced at the top of the page, only 37% of people saving for a college fund use a 529 plan.
Shockingly 61% just use their bank’s savings account! I say shockingly because they generally just earn less than 1%.
My own Credit Union as an example offers a rate of between 0.20%; 0.15%. I’m not sure about you, but if you’re trying to grow your money over a period of years, that’s pitifully low.
But don’t take my word for it! Listen to the esteemed Dave Ramsey talk about how someone with no savings can still make it happen!
So what are my . . .
5 Best Types of College Savings Accounts for Your Kids?
1. 529 Plan
Essentially a Roth IRA to be used specifically for education purposes.
You invest money after you’ve paid taxes on it. You can invest up to $14,000 per year, so it’s very generous that way. Then it grows tax-free invested in mutual funds. When you take it out, as long as it’s being used for education purposes, you pay no taxes on it. One of the downsides of this plan is that details can vary by state.
So if your state has state income tax, it would be a good idea to double check and make sure you won’t pay state tax when you use the funds.
Another downside is that currently, you can only modify your investments once per year. If you find you cannot use the funds for education though, you’ll pay both your tax rate and a 10% penalty to cash this out.
You can see some additional details on 529 plans from the government’s US Securities and Exchange Commission. And you can check any of the 50 states’ rules on 529 plans by going to this page on CollegeSavings.org.
However, this (in my opinion) is the best of the types of college savings accounts.
2. Coverdell Education Savings Account
Similar to the 529 but more limited in terms of what investments are available.
Like the 529 you put money in after you’ve paid tax and then when you use it for education purposes, it can be withdrawn tax-free. It’s also more limited than the 529 in terms of how much you can contribute annually (no more than $2000/year).
However, it can also be used for private schools starting at elementary age. Limited to an individual making less than $110,000 or a married couple making less than $220,000. See the complete list of IRS rules and limitations.
3. Prepaid College Plan
Essentially this is a pay up front plan, not necessarily offered by all colleges or states.
Unlike saving in your accounts, you pay tuition now for future use. The only real benefit here is that if you pay today, you’re paying today’s rates as opposed to what they will be in the future. If we do some simple math though, we know that college tuition increases roughly twice the rate of inflation.
Inflation rates have varied between 1 and 3% per year according to InflationData.com.
That means you can expect college costs to go up anywhere from 2% to 6% per year. If you can earn anywhere close to 10% in your college fund in a 529 account, you can clearly see why the prepaid route isn’t a great option.
One benefit of this plan is that often they allow you to transfer to another immediate family member; useful if one child opts to not go to college. In most cases, however, if you ask for a refund due to no child attending college, you’ll not only pay your tax rate, but also a 10% penalty.
4. Using a Traditional or Roth IRA
Not a great option of the types of college savings accounts, in my opinion. While the IRS probably won’t charge you the standard 10% penalty if you cash out for education, they may charge tax.
As you’ll see in the IRS link, they are a little vague, stating “You may owe income tax on at least part of the amount distributed, but you may not have to pay the 10% additional tax.” I don’t know about you, but I don’t want to count on the word “may”.
5. Savings Account
An absolute last resort if, for some inexplicable reason, the others aren’t an option for you. You need to contribute more each month. You’ll also need to put money in for a much longer period of time to even come close to the others
What if you are late starting your college fund?
As you saw in my above calculations, you could save as little as $60/month from the time your kid is 5 until they are 18 and (if invested well) could end up with about $18,000.
But what if your child is 10 or 12 or even older? That just means we need to act quickly and we need to invest more. Using that same compound interest calculator, I plugged in $130/month for 8 years (ages 10 to 18). Believe it or not, saving just $130/month still covers that $18k bill.
Starting when they are 15? That’s cutting it close, but $400/month will do it.
Do bear in mind, however, that mutual funds (what a 529 account would typically be invested in) average an interest rate over a long period of time. So 3 years is not a lot of time. Thus, you may see more varying (and thus lower) rates of return.
That should NOT sway you from starting though! Just know it may not quite cover the total costs so you may need to pick the least expensive college in your area, have them live at home and cash flow the difference.
But select from one of the types of college savings accounts today!
So depressing but true! : ( Honest Game of Life – Read them all, they’re hilarious. pic.twitter.com/7ksGLOdePQ
— Madalyn Abbey (@LexingtKyFAL) February 25, 2017
So what are my . . .
5 Reasons you need to start College Savings Accounts for Your Kids today?
1. AVOID THE STRESS
If you wait until they are a senior in high school your options are few: student loans, cash flowing it or not going. None of those are great options and can cause serious strife in your house!
2. PEACE OF MIND
As with anything in life, we can either plan and map out where we want to be in 3, 5, 10 or more years or we can leave it to chance and hope for the best. When we plan for the future, even if it doesn’t go exactly as planned, that still gives us significant peace of mind. The alternative is just endless worrying about how you’re going to make things happen.
3. STAY OUT OF DEBT
We already covered how the average college student comes out owing over $30,000 and will likely only be making $50,000/year. When we or our kids are saddled with that kind of debt it’s the financial equivalent of tying a rope to a cinder block and attaching the other end of the rope to their leg and pushing them overboard.
4. LET YOUR MONEY WORK FOR YOU!
Saving early into a 529 account means you get the benefit of compound interest over a period of years. Choose your investments right and that could be upwards of 10% compounded interest per year!
5. GIVE YOURSELF AND YOUR KIDS OPTIONS!
By saving $18,000 or more, you’re giving your child options for their future. They don’t have to settle. Save even more and their options increase. They can follow their dreams and passions and you made it happen; priceless!
How could this post have been better? Are there other types of college savings accounts you wish I had covered?
Feel free to comment here or email me with any questions as I am here to help!
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