Hi, I'm Candace
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18 years sound like a long time to save for your child’s higher education, however according to Sallie Mae, only 56% of parents are actively saving. Of those parents, the savings average around $18,000 which wouldn’t cover one year of tuition, fees, and room & board at an in-state public institution, according to College Board.
The outrageous price tag for college (estimated to be on average about $20,000 a year for an in-state university) and the lack of savings, has led to historic levels of student debt for recent graduates.
So what to do? Here is a simple savings rule: Saving for college is easier the earlier you start.
Start early and start small. For example, if you are able to save just $500 per year for 18 years, you will have saved nearly $20,000 by the time your child is ready for college, assuming you’ve invested in a plan that averages a 7% return annually. Save $1,000 per year for 18 years and you’ll have nearly $40,000… make that $2,000 a year and you will have saved close to $80,000. That’s huge!!
So where do you begin? Below are several different types of accounts and what you need to know about them.
Open a standard bank savings account, money market account, or CD.
Pros: Zero risk. If your child decides they don’t want to go to college, they can use the funds for anything.
Cons: The interest rates on savings accounts are negligible (1% if you’re lucky). Money market accounts can yield slightly higher rates (around 1% to 2%) and the top 5-year CDs on Bankrate offer a yield of just over 3%. Compared to the S&P 500 that delivered a total return of 13.4% over the past five years – you’re definitely missing out on building your savings quickly.
Similar to a Roth IRA, a 529 plan allows you to invest after-tax money into diversified, low-cost stock and bond funds and then withdraw the money tax-free for qualified education expenses. Money in these accounts can be used for undergraduate and graduate studies, including tuition, fees, books, room & board, and computer equipment/software that is required. Further, with the 2018 tax reform, these accounts can also be used for private elementary and high school tuition.
Pros: Big tax advantages. The gains are tax-deferred, and once the funds are used to pay for qualified tuition expenses, parents will never pay taxes on those funds.
Cons: What if your child doesn’t go to college? You have a little flexibility. You can change the beneficiary to another child, niece, nephew, grandchild, etc. so someone else can use the funds for education. If you withdraw the money for unqualified expenses then you will have to pay income tax and a 10% penalty on the earnings.
A prepaid tuition plan is designed for parents who are sure that their child will attend an in-state public university and allows them to simply pay for tuition credits in advance at a predetermined price.
Pros: Prepaid 529 plans retain the same tax and parental protections as 529 college savings plans, but without being subject to swings in the stock market.
Cons: The major limitation to a prepaid plan is that if your child decides to go to school out of state, you’ll get a return on your money, however you will not get the full value of the plan.
As with any investment, the earlier you save, the more time your money has to grow. If you haven’t started saving, and your child is nearing high school or later, there’s still value in opening an account.
Candace is the founder of NewWay Accounting and is a CPA who specializes in working with fellow entrepreneurs. She strives to take the fear and anxiety out of taxes and help empower small business owners to feel more confident and in control of their finances. Because even if money isn’t your jam, you deserve to be successful too!
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