How to Start Saving for College and Alternatives to 529 Plans
It’s the quintessential question of any new parent — and it can remain on your mind as your child grows and gets older: how are you going to pay for their college?
And with the way things are now, saving for college feels intimidating as the cost of higher education continues to rise. Many parents are also motivated by their own student loan debt, wanting to start saving for college to help their children as much as possible, so they don’t face the same financial struggles.
The easiest way to answer the question of when you should start saving is “as soon as possible.” But it’s not always so simple — and it’s certainly not easy to do.
It helps to understand a few strategies that will help you start saving for college, including how to set up a system for saving and where to put the money you earmark for your child’s education.
Do This Before Saving for College
Parents tend to want to open up a savings account for their child as soon as they arrive in the world. But there’s something else you should do first: make sure you have your own financial bases covered.
- Having an emergency fund. Ideally, you want to save 3 to 6 months’ worth of income in cash to help you cover unexpected costs. With children comes more financial responsibility, so it might be smart to err on the side of caution and aim to save on the bigger end of that spectrum.
- Contributing 10% to your retirement savings. This is a minimum amount. Ideally, you should save 15% to 20% of your income for retirement. Take advantage of employer-sponsored plans with a match first if you have access to them, and then save in tax-advantaged accounts.
- Paying off personal and consumer debts. Aim to pay off high-interest rate debt first (like credit card balances). If you can pay off your student loans, do so — but at the very least, have a repayment plan in place and make sure the monthly payments on the loans are manageable.
No, it’s not selfish to take care of your financial needs first. By doing so, you help avoid becoming a financial burden on your children later in life.
There are a wide range of options available to help kids pay for college. Parents don’t need to 100% fund these costs alone. It’s much more important to ensure you can pay for things like your own retirement — because “retirement living loans” just don’t exist the way student loans do.
How to Start Saving for College
Once you’ve taken care of your own financial needs, then you can turn to saving for your kid’s college. Just like investing for your own future, the earlier you start, the better. That’s because you don’t need to sit on cash savings. You can invest that money to help it grow over time.
There are special accounts and plans that are specifically designed to help parents save for college. It’s important to use these accounts, not just because they allow you to invest but also because they could impact the kind of future financial aid your child qualifies for.
Financial aid is, in part, based on the amount of assets a family has. If you leave all your college savings sitting around in cash and in your child’s name, that could impact their ability to receive funding or grants.
You can play around and see how different kinds of assets will impact the amount of financial aid that could be awarded with this tool from FAFSA.
If you’re confused about where to put your assets, here are some popular college savings accounts and plans to consider.
The Pros and Cons of 529 Plans
529 plans are some of the best known and most popular college savings vehicles. Plans are operated by individual states or institutions.
These can can help you keep more money in your pocket (to use for savings) because they offer a number of tax advantages. You can deduct contributions and you don’t need to pay tax on the earnings in the account.
Other advantages of 529 plans include:
- Allowing you to invest what you save for college, so that money benefits from potentially earning returns and enjoying compound interest growth.
- Being specifically for college savings, making it more likely that families will maintain the account for college costs (since there are penalties for withdrawing the money and using it for other purposes beyond qualified expenses for higher education).
- Providing a way to invest money with low minimum deposit requirements to open an account and start saving. Traditional brokerage accounts require users have $1000, $3000, or even more to open and use. There are 529 plans with minimums as low as $15.
There are some downsides to be aware of, too, before opening a 529 plan:
- Many 529 plans come with high fees, which can eat into your earnings over time.
- You’re limited to where you can invest. 529 plans offer access to certain funds, but not all — you may not be able to invest your money exactly where you want, like you could with a regular brokerage account.
- If you don’t use the funds in a 529 plan for education expenses, you could face pretty hefty fees. These can include charges of up to 10% — and both your state and the federal government may impose penalties.
Talking with a fee-only financial advisor working as your fiduciary is an important first step before choosing a 529 plan. You have a lot of options, and many variables influence the specific plan that’s best for you and your family.
Savings Alternatives to 529 Plans
529 plans are great options. But they aren’t the only ones you have. Other alternatives may work better for you, depending on your financial situation.
If you decide a 529 plan isn’t for you — or you just want to compare it to your other options — you can look at one of the following plans to help you save for college:
Prepaid Tuition Plans
Feel positive your child will attend a university in-state? A prepaid tuition plan allows you to prepay the cost of college at a set price.
Basically, you pay for tuition today at present rates. Then your child can redeem the credits in the future. The idea is you beat challenge faced by many families: the skyrocketing cost of higher education.
But these prepaid tuition plans are sponsored by the states. That means you rely on your state to come through years into the on what’s essentially a promise for now. Some states have formal guarantees. Others don’t. It’s a different kind of risk than what you face when you invest in the stock market.
Plus, if your child chooses to go out of state, you don’t lose your credits — but they do lose some of their value.
UGMAs and UTMAs
These are more than just funny-sounding acronyms. UGMA stands for “Uniform Gift to Minors Act” and UTMA stands for “Uniform Transfer to Minors Act.”
Parents can set up these accounts to help their children financially — whether the money is used for college or not. The funds just need to be used in a way that benefit the minor.
This can be helpful if, after years of saving, you child decides not to go to college. They’ll still have a nest egg to help them get started with their adult lives. Of course, that’s a downside, too. Kids eventually have much more control over the funds than they would if the money were in another type of savings or investment account.
There’s not much that needs to be said about the fact that not all 18-year-olds make the best long-term financial decisions for themselves!
IRAs or Taxable Brokerage Accounts
You could also use IRAs in your own name if you will be at least 59 and ½ before your children need the money for college. This allows you to withdraw the funds without penalty, while allowing you to invest the money the way you want before it’s needed.
Or just stick with a regular taxable brokerage account. You won’t get a tax break here and you’ll even pay taxes on gains, but you also have a lot more freedom in when and where the money is used.
You have a lot of options when it comes to saving for college for your kids. That’s a good thing because it means you can create the strategy that makes the best sense for you and your family.
But it can also get overwhelming through the sheer number of choices you need to sort through and make. You don’t have to do it alone. That’s what a great financial planner is for: to help you look at your situation, understand the options, and move forward on the best path for you considering all the variables and your own personal goals and values.
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