With the ever-increasing costs of college, starting to save for a child’s college expenses can feel like a daunting endeavor. Not to mention balancing saving for college with the myriad of other financial priorities you or your family may be working towards such as your own long-term financial security. However, as with any financial goal, it begins by prioritizing and having a well documented and outlined goal that you’re working towards. For example, simply saying you want to help with your child’s college expenses is great, but how you save, how much to save, and where you save, are all important factors to consider. This article will explain money saving tips for college that are easily implemented!
Determine How Much, Where, and How to Save
On this page, we’ll talk about three different things you need to consider when saving money for college. It’s important to think about how much you need to save for college, what college saving account is right for you, and how to effectively save money for college.
How Much Money Should You Save for College?
If you’re in the early stages of saving for college, it can be hard to determine exactly how much you’d like to save for your child. The costs can vary wildly from in-state public tuitions to out of state private schools. Is it important that your child have a choice in where they choose to go? Or will you dictate the school based on what’s affordable and what you’re able to save?
Once these questions have been addressed, a potential number to shoot for in terms of how much to save for college is around 50% of estimated costs. For example, if you’re shooting to save for 50% of the cost within a tax-advantaged account such as a 529 plan, you’re likely able to adequately save for college while also not forfeiting saving/investing for other goals. Not to mention, once funds are in a 529 and designated for school expenses, those funds cannot be used for anything unless you’re prepared to pay a hefty 10% penalty on the withdrawals.
Any additional savings above the 50% target could be saved in a taxable account earmarked for college, which doesn’t have the tax benefits of a 529, but would have more flexibility in being able to still use towards college expenses OR other goals. This can be beneficial especially if your child ends up receiving scholarships, financial aid, or decides to attend a college on the cheaper end of the spectrum, in which case the entirety of the 529 funds may not be needed.
Because college expenses will likely continue to change over the course of the next decade(s), there isn’t a magic number as to what parents should begin saving for their child’s college expenses. The key is actually starting to save and having a baseline target to start working towards based on projections without sacrificing your ability to works towards other financial goals as well.
What College Savings Account is Right for You?
There are a few options in terms of college savings accounts.
1. 529 Plans
As mentioned previously, a 529 is a great way to save for college expenses in a tax-advantaged way. If your state has its own 529 plan you may also receive a deduction on contributions to the plan. If not, you’re still able to benefit from tax-free growth within the account. Meaning, as your investments in the 529 grow, you’re not paying taxes every year on investment gains or dividends and interest. Rather, you’re allowing the totality of those gains, dividends, and interest to remain invested and continue to compound. Resulting in a much larger overall return than what would otherwise be earned in a “taxable” account.
Keep in mind that 529’s MUST be used for eligible expenses or the earnings portion of the distribution will be taxed and also incur a 10% penalty.
Therefore, ensuring what’s contributed to a 529 is specifically used for schooling expenses is key. If you’re worried that you’re potentially overfunding, it can be a good idea to instead invest outside the 529 as discussed earlier. This would provide more flexibility in what you can eventually use the funds for, whether that’s for college expenses or other financial goals.
6 Benefits of a 529 Plan
The 529 plan is one of the most popular ways to save for a child’s college expenses. As the cost of higher education continues to increase at an astronomical rate, it’s more important than ever to plan for your child’s college expenses using tax-advantaged accounts such as the 529. Below we’ve listed the several benefits of a 529 plan.
- 529 Plan Tax Benefits: The 529 plan allows earnings to grow tax-free. Meaning the money you invest in a 529 is never taxed unless you distribute the funds for non-qualified education expenses. Qualified expenses are withdrawn tax-free and can range from room and board to laptops. Tax beneficial accounts should always be taken advantage of for their specific purposes, in this case, saving for college. Lastly, in many states, you can get a tax deduction or credit for contributions to a 529 account.
- Control of the Account: As the owner of the account, you can ensure the money is used for its intended purpose. Unlike a taxable brokerage, or UGMA/UTMA account, the child has no legal rights to the money. As the owner, you can withdraw money at any time for any reason. However, keep in mind there’s a 10% penalty on money not used for education expenses.
- Anyone can Contribute to a 529 Account: Anyone can contribute to a 529. If you’ve let your family know you’ve opened a 529 account for your child to relieve some of the costs of attending college, the family can make contributions to the account as well.
- 529 Plan Investment Options: 529’s offer a variety of investment options ranging from mutual funds, ETF’s, risk-based, and age-based portfolios. We highly recommend automating the investment process with 529’s by linking a bank account and making monthly contributions. If you’ve saved up a good amount already, it may be smarter to make a lump sum contribution so the money can work in a tax-free account sooner. Lastly, reviewing the investments and progress at a minimum on an annual basis is a good idea to ensure the investment remains in line with your risk tolerance and timeline until your child begins college.
- Front-Load Contributions: If you have a large amount of money already set aside for a child’s college expenses, 529’s allow you to front-load contributions. A contribution of $18,000 or $36,000 for married couples, qualifies for the annual federal gift tax exclusion. For wealthy individual’s, this allows you to give away money without counting against the 5 million lifetime exemption used for calculating estate taxes. You may also make contributions up to 5 years worth of contributions in one year. For example, let’s say your parents want to fund your child’s education, and they have $100,000 set aside for that purpose. They are eligible to contribute the entire $100,000 to your 529 accounts benefiting your child in one year. This allows the money to grow tax-free sooner, with the end result being the child ends up with more money for college. In fact, it can benefit your parents as well by removing the $100,000 from their estate without having to pay any extra gift tax.
- Ability to Change Beneficiaries: 529 accounts allow the owner of the account to change its beneficiary without limitation. If your first child, whom the 529 is slated to benefit, doesn’t attend college or doesn’t use all the funds in the account, you can change the beneficiary to another child or family member. 529’s never expire, and they can be passed down from generation to generation. The flexibility and tax benefits of 529 plans make it one of the best ways to fund college expenses. As a result of the new tax bill, 529’s can now fund K-12 education as well, in addition to college. If you have questions about 529’s or how setting one up might be in your best interest, schedule a free consultation with us today.
2. UTMA/UGMA Accounts for College Savings
UTMA/UGMA accounts are custodial accounts that pass to the child once they reach the age of majority (typically 18 or 21 in most states) at which point in time the account becomes theirs.
This is advantageous if wanting to gift funds to the child for expenses outside of college such as purchasing a car, home, etc.
However, because the fund is the child’s once they reach the age of majority they can use the funds for whatever they please which could go against your wishes. Secondly, the funds are counted as an asset on the child’s balance sheet when applying for financial aid which could negatively impact the aid they receive.
3. Roth IRAs for College Savings
Roth IRA’s can be used for college savings since the contributions of the account can always be tapped into tax and penalty-free.
However, the argument to save in this way is small, since in an ideal situation you’re not using funds from a Roth IRA to pay for college expenses, you’re using them for your own long-term financial security.
In most cases, the 529 and its tax benefits outweigh the other options when it comes to saving for college expenses.
How to Save Money for College
As with most financial goals, automating finances can ensure you’re making meaningful, tangible progress over time while reducing the stress of having to manage it on a week to week or month to month basis.
1. Set Up Automatic Contributions to a 529
Setting up automatic contributions to a 529 that aligns with when you get paid, is an easy way to ensure you’re prioritizing college savings. Over time, as your pay increases, consider allocating more of your savings towards the 529.
2. Lump Sum Contribution to a 529
If you receive a large cash infusion whether from bonus pay, exercising stock options, vesting RSU’s, or whatever it might be, consider using a lump sum contribution to the 529. The more you’re able to contribute to a 529 early on, the more time you have to benefit from the tax-free compounding of investments. T
he same principle rings true in retirement savings. Rather than waiting until you’re 50 to start saving for retirement, it’s smart to start early because the funds have more TIME to benefit from compounding. For example, if you’re able to contribute a lump sum of $17,000 at the start of saving for college expenses with another 15 years until your child will use the funds, the $17,000 contribution is likely going to result in a larger balance at the end of the 15 years than if you were to contribute $94.44 every month for 15 years since the entirety of the $17,000 will benefit from being invested at the onset as oppose to small portions over the long period of time. Of course, there are also the factors of market performance and asset allocation within the 529 itself that predicate long-term investment success.
3. Front-Load Your 529
529’s are also unique in the sense you’re able to front-load up to 5 years of the gift-tax amount towards contributions. In 2024, the gift-tax-free amount any individual can gift to another without reducing their lifetime exemption is $18,000. If you gift $19,000 it starts reducing your lifetime exemption amount.
Without getting into the weeds about gifting and estate taxes, ideally, you want to avoid reducing the lifetime exemption if able, since we don’t know what gift and estate taxes will look like down the road. In this case, if you or a family member (potentially grandparents looking to gift to grandchildren) can contribute up to $85,000 upfront to the 529 and the account can then benefit from compounding for longer! This also won’t impact the individual’s gift/estate tax exemption while also allowing them to gift the cash for “free”.
Saving Money for College Can Be Easy
The earlier you’re able to develop a college savings strategy the more likely you’ll be able to successfully integrate it into your holistic financial picture. It can be difficult to balance the myriad of financial priorities as a young family. The key is to have conversations, prioritize goals, and automate finances when able. Over time, implementing these money saving tips for college helps simplify decisions, personal finances, and the ability to achieve financial goals.
If you’re ready to start saving for college, have questions about 529’s, or need help figuring out how to balance the variety of different financial goals young families are looking to accomplish, schedule a free consultation today!
