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When Should Parents Start Saving for College?

When Should Parents Start Saving for College?

In 2019-2020, a college education cost $9,400 at public four-year institutions and $36,700 for private nonprofit four-year institutions. At private for-profit four-year institutions, the average tuition and fees was $19,100 in 2019 to 2020.

There are more higher education costs as well, including books, supplies, room, personal expenses, board and transportation. (As you know, the cost of college isn’t getting cheaper.)

In this piece, we’ll walk through when you should start saving for college, options for college savings and steps you can take to save.

Let’s dive in!

When Should You Start Saving for College?

The more you save now, the more money your child will have for college later. The more you save now, the less your child will also have to borrow later. It’s important to save early on so you can build interest, dividends and/or capital gains on the money you save. You can build using compound interest — interest that builds on itself over time.

You’ll want to take advantage of compounding because average costs pulled from Northwestern Mutual say that in five years, a four-year college degree will cost $113,232 at a state university and $259,188 at a private school. In 10 years, you’ll pay approximately $155,720 for a public university or $356,443 at a private college. In 15 years, college will cost around $198,743 for a public college or a whopping $454,992 for a private college. Those

Therefore, it’s important to put a college savings plan into place ahead of time so you don’t have to rely on student loans later on.

It’s fair to say that as soon as you know you’re having a baby, you may want to start a college fund. However, it’s okay to start an education savings account later for future education expenses. In other words, if you don’t get around to it until your child is 10 or even 17, it’s still worth doing.

How to Save for Higher Education Expenses

How do you save for future college expenses? Let’s go through a few steps you can take.

Step 1: Consider your savings goals.

The best plans start out with a goal. When is the best time to start saving? How much do you want to save for your child’s college education? How much is a reasonable amount to save per month? It’s nice to say, “I’d like to save the full $454,992 that it’ll cost for a private college in 15 years.

However, remember that your child may get scholarships (free money you don’t have to pay back). In addition to that, you must still stuff your own retirement accounts because it’s likely that Social Security won’t offer you enough money to retire on. Your retirement must remain the number one factor — you can’t get financial aid for retirement. (Also make sure you have an emergency fund.)

So, identify an amount that makes sense for future savings and also one that jives with your budget right now — after you earmark money to set aside for retirement savings.

Step 2: Identify a savings method.

Identifying a college savings account might be the hardest part of saving for college because you have so many choices! In fact, it’s the part that trips most people up because they just don’t know what to do. Let’s go over a few options below:

  • 529 college savings plans or 529 plans: 529 plans are operated by states or educational institutions and offer many several investment options for your account. You can choose the risk level you’d like to have for your account. For example, if you want to invite maximum risk (in hopes of maximum returns) you can opt for that. If you’re a more conservative investor, you may want to opt for a more conservative mix of stocks and bonds. Your contributions accumulate tax deferred, which means you don’t pay income taxes on your earnings. When you make withdrawals to pay the beneficiary’s qualified education expenses (such as tuition, books, fees, supplies, room and board), your earnings are federal income tax-free from federal income tax. You can also transfer beneficiaries if one child decides not to attend college. By federal law, contributions to a 529 plan cannot exceed the expected cost of your beneficiary’s stated college expenses. Limits vary by state and can range from $230,000 to $530,000.
  • Prepaid tuition plans: Prepaid tuition plans give you the same tax benefits as 529s and allow you to pay for college by locking in today’s prices. In other words, you can buy four years of college now instead of paying for larger college costs later on. However, you can only choose from an in-state public institution. The program may only cover tuition (not room, board and fees) and your state might actually shut down the prepaid tuition plan program.
  • Coverdell ESA: Another tax-free method of saving for college, you can invest up to $2,000 annually per child in an ESA on an after-tax basis. Earnings accumulate tax-free from income taxes and you must use the money for qualified education expenses. You cannot contribute beyond age 18. Any growth in the account would not be subject to income or capital gains taxes when the beneficiary pulls money out as long as it goes toward qualified educational expenses. Funds not used for education by the time the child reaches age 30 must be transferred from that child’s name to a younger beneficiary or withdrawn. Otherwise, you’ll pay tax on the earnings and a 10% penalty.
  • Custodial accounts: The Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) are custodial accounts, which name an adult as the “custodian” of the funds in the account. The minor owns the money in these types of bank accounts but is managed by the adult custodian. The funds must be turned over to the minor when they turn the age of majority in their state. Whether you set up a UGMA or UTMA depends on individual state requirements. Over time, the funds in a custodial account could grow, thanks to investment returns or reinvested dividends. However, it’s worth noting that a minor can do whatever they want with the money when they become an adult.
  • Roth IRA: You might think of a Roth IRA as a retirement savings vehicle only. However, many families choose to use it for college savings as well. You can withdraw contributions to Roth IRAs prior to age 59 1/2 to pay for higher education. This means you could withdraw some or all of your Roth IRA principal for college tax-free and leave the earnings in the account for retirement.

Don’t forget that you can also invest in traditional investments, but remember that you won’t be able to tap into specific tax incentives that educational investments can give you. For example, you can invest in mutual funds with a financial advisor but you won’t get income or capital gains tax benefits.

Step 3: Set up your plan.

Next, you’ll have to choose your brokerage or other type of account you want. If you have a brokerage account you already want to use, go for it. You can also ask a financial advisor for specific guidance.

If you have no access to a brokerage account, start with UNest. UNest makes it easy for parents to invest in their children’s future with a simple, flexible, and tax-advantaged custodial account for minors. Plus, your family and friends can contribute funds to your child’s UNest Investment Account for Kids through a shareable gift link.

Family and friends easily contribute to a child’s account for holidays or special occasions. You can also earn rewards when you sign up for or shop with your favorite brands. You can also refer your friends (those with kids!) to UNest to earn money.

Step 4: Invest.

Choose a set amount that you want to contribute toward college and invest that amount per month. For example, if you’ve decided that you want to contribute $500 per month, you can have that amount withdrawn every month. However, if you want to have more flexibility, you can adjust your investment per month.

Start Saving as Soon as You Can

The earlier you can start saving, the better! But even if you don’t get around to it until your child is in high school, it’s okay. Just remember that whatever you can do can eliminate some student loan debt that your child will have to pay back later on in life.

There’s always value in opening an account. It’s nice to have tax benefits, but if you save somewhere else, that’s okay. At least you’re doing something to save. Pat yourself on the back!

Don’t forget that UNest can offer many opportunities to simplify access to investing for your child’s future.

The minimum contribution is $25 per month. We start you off on this plan to help you get started saving for your children. You can choose to increase this monthly contribution at any time.