Some people say it’s not worth saving for college. After reading this article, you should agree that “Saving a Dollar Today is Better than Borrowing One Tomorrow”®.
Parents who can save a little each month will SUBSTANTIALLY reduce the total future cost of their child’s college and may even jump-start their children’s retirement accounts. This simple example shows how:
- Benefit of Saving: Saving $100 per month with a 6% rate of return compounded daily over 18 years will provide approximately $38,800 to pay for college.
- Result of Borrowing: Upon graduation, a student who had to borrow $38,800 (at 6% interest rate payable over 10 years) faces a student loan bill of roughly $430 each month for ten years and pays a total of approximately $51,700 in principal and interest for that loan.
- The Consequences: Saving a smaller amount ($100) each month over a longer period (18 years) avoids borrowing a large amount ($38,800) paid over a shorter time frame (10 years).
- Good News for Savers: Savers paid approximately $51,700 less for their degree than the borrowers, which means the return on their education investment is greater than someone who had to borrow to pay their college bills.
- Better News for Savers: A recent graduate who can invest $430 per month (the amount they would have been paying on their loan) for 10 years with a 6% return would build a nest egg of approximately $70,500. If they did not add $1 for the next 35 years and kept investing at 6%, their nest egg would grow to approximately $572,000.
Examples like this depend on the assumptions. No matter what the assumptions may be, the point will be unchanged: saving for college will reduce the total cost of your child’s education, better position them for financial success, and maybe even help jump-start their retirement savings.
How to Save for College
The most important first step: start today. For some families, the start of college is way in the future, maybe more than a decade down the road. So it may seem like there is no sense of urgency to start saving for young children. The problem: the days are long, but the years are short. The toddler you fondly remember will be asking for the car keys in what will seem like the blink of an eye.
The second most important step: choose a savings account that makes sense for you. One very popular way to save: 529 Plans, which have tax advantages and can be used for more than just college expenses.
529 College Savings Accounts provide many incentives for families to save for future education expenses:
- 529 accounts can be used for Qualified Education Expenses including:
- College expenses, such as tuition, housing, food, books, supplies, computers, etc. In addition to federal tax advantages, many states also offer state tax benefits (credits or deductions).
- Up to $10,000 (soon $20,000) of K-12 tuition and expenses.
- Up to $10,000 of payments on student loans.
- Enrollment in approved apprenticeship and certificate programs.
- Significant tax benefits: Unlike brokerage or other taxable accounts, neither the interest and gains on the 529 investments nor withdrawals for Qualified Education Expenses are taxed.
- What happens if a student doesn’t go to college or the money can’t be used? If a student does not go to college or if money is left in the account after graduation, the account owner has options:
- Don’t do anything. There is no requirement to close an account after a student completes school. Perhaps they will go on to graduate school or have another QEE in the future.
- Allow the beneficiary to roll up remaining savings into a Roth IRA. Subject to certain restrictions, beneficiaries may roll up to $35,000 of leftover 529 Plan investments into a Roth IRA without penalty.
- Name a new beneficiary. Account owners may easily change beneficiaries, even to themselves.
- Make a non-qualified withdrawal. The Account Owner may make a withdrawal for non-qualified expenses, incur a 10% penalty and pay taxes on the earnings.
- No income restrictions: Anyone, no matter their income, may own and contribute to a 529.
- Not state specific. Savers may pick any 529 Plan Savings Plan in the country for use at schools in any state. You can find and compare 529 programs here.
- Financial Aid Friendly: Families concerned that their savings may affect their eligibility for need-based financial aid should understand money saved in a 529 plan is weighed against financial aid eligibility at a maximum of 5.64%. For example, $10,000 saved in a 529 could end up reducing financial aid eligibility by $564.
- Beneficial for estate planning: Account owners, typically parents and grandparents, prefer 529s because they control how monies are invested but without having the investment assets included in their taxable estate. 529 Plans also permit lump-sum contributions equal to five years of the annual gift tax exclusion (currently $19,000) to a beneficiary in a single year. This means that up to $95,000 (for single filers) or $190,000 (for joint filers) at once, per beneficiary, without having to pay gift taxes.
Saving for college is an important way to minimize college debt, reduce the overall cost of obtaining a degree and allow recent graduates to save for their future rather than pay for their past. Congress created tax-advantaged 529 Plans in 1996 to encourage savings for college and has since expanded the program to make them a preferred college savings vehicle.
® – Invite Education LLC