It’s no secret that today’s college graduates are drowning in student debt. And even though the government recently voted to keep student loan interest rates relatively low, there’s no guarantee that they’ll stay low in the future.
With graduates (and many who went to school without ever getting a degree) owing an average of $24,000+ in student loan debt, college planning is becoming more important than ever.
Whether your child is eighteen months or eighteen years, it’s never too early – or too late! – to save for college. Understanding and following these basics of saving for college could keep you and your child out of school-related debt down the road:
1. Start early
Obviously when it comes to any sort of savings, the earlier you save, the better off you are. But just to put it into perspective, let’s say you start saving $100 per month when your child is born. By the time she’s eighteen, you’ll have saved $33,758, assuming a 5% annual rate of return.
Wait until your child is five, and that same $100 per month turns into just $21,255 per year. If you don’t save at all until your child turns ten, you’ll sock away just $11,458.
While you still have hope for paying for college if you wait to save until later, you’ll be much better off if you begin saving as early as possible!
2. Understand your options
Several different college savings options give you plenty of choices, so you’ll want to educate yourself about your main choices before you decide how to save for college. Here’s a quick overview of some of the main available options:
Coverdell Educational Savings Account: This account lets your savings grow tax-free, so you keep more money. You don’t have to pay income tax on the earnings, as long as you use the money for educational expenses. This account can be used for college or even certain elementary and secondary school expenses.
529 Account: Each state sponsors one or more 529 plans. These accounts also grow tax-free, but they can only be used for qualified higher educational expenses.
UGMA/UTMA Account: Under the Uniform Gifts for Minors Act, you can set aside money in a regular savings or investment account and act as the custodian of the money on your child’s behalf. While earnings on UGMA accounts are taxed, you can use this money for anything your child needs – from a car to college tuition.
Educational Savings Bonds: Savings bonds are a low-risk way to save for your child’s education. Like other education-specific savings vehicles, the interest on these bonds isn’t taxed, so you maximize earnings as long as you use the money for college.
These are the main college savings options, and I’ve only given you a very brief overview. Before you start saving, look into each of these options to determine which one will work best for your particular needs.
3. Don’t aim for 100%
The fact of the matter is that you have to make a lot of money to pay the full sticker price for your child’s college education. Nearly all families – even high-earning ones – get some sort of student aid.
Of course, some of that “aid” is actually in the form of relatively low-interest loans (and, remember, there are no guarantees that the interest rates will stay low!), but much aid from more-expensive private schools, in particular, is in the form of scholarships and grants.
So when you’re looking at college savings calculators trying to set a savings goal, don’t kill yourself trying to save for 100% of the future cost of your child’s education. (Which, if costs keep rising at 5-8% a year will be astronomical, even for a state school!)
A more reasonable goal is to aim to save up between 35% and 50% of your child’s total estimated future education costs. But even if 35% is way out of reach, any little bit counts!
4. Save automatically
As with saving for retirement, when it comes to saving for your child’s college education, automation is a great idea. Have a certain percentage of your paycheck automatically put into your child’s education fund every month, and you’ll never even miss that money.
Without automating savings like this, you’re more likely to find ways to spend that money that your child will need for college later on. So do yourself a favor and sign up for automatic withdrawals!
5. Put retirement first
This is absolutely key, and it can be a very difficult concept for parents to grasp: you must get moving on your retirement savings plan before you save for your child’s college education.
Financial planners liken this approach to a flight attendant’s admonition to secure your own oxygen mask before helping your child. It seems counterintuitive to parents, who are hard-wired to sacrifice on their children’s behalf, but doing it this way can save both you and your child.
When it comes to retirement vs. educational savings, remember that your child can borrow in the future – or get scholarships, or work through college, or find any number of ways to make up for a lack of savings.
You, on the other hand, won’t have many options for funding retirement other than your own savings, since pensions have all but disappeared and Social Security may not hold out forever. So before you even think about putting a monthly contribution into your child’s savings account, start saving for retirement.
In the meantime, you can always start that college account with money gifted to your child for Christmas and birthdays, or require part of his or her part-time job earnings to go towards college savings!
–Abby Hayes is a freelance personal finance writer and contributor for personal finance blog Dough Roller. She spends her spare time bargain hunting for her family of three.