How Much Does College Cost?
Americans hold $1.7 trillion in student debt, and while some students may be allowed to discharge part or all of their student loans, many will not be so lucky. Parents plan to cover about 70% of their children’s college expenses on average – but less than 30% of them are on track to do so, according to Fidelity’s tenth annual college savings indicator. The best time to start saving for your child’s college education is now, and perhaps the best way to do that is simply to start doing it. The earlier you begin, the better: compound interest works like a strong wind. There are some specific tools and services that can help you reach your goal faster, including 529 accounts, scholarships, or a dedicated plan set up by a financial advisor. The bottom line: It’s never too late to start, no matter where you find yourself on your savings journey.
How Much Does College Cost?
Currently, the average cost of tuition and fees for four years at a public college in-state is $42,240. For an out-of-state public program, the average cost is $108,080 for four years. If your child plans to attend a private institution, the average cost is $150,600 for four years. Room and board, which includes on-campus housing and meals, adds an average of $46,480 for four years at a public college and $52,480 for a private college, bringing the total to $88,720 for an in-state public college, $154,560 for an out-of-state public college, and $203,080 for a private institution. These numbers are likely to continue rising: prices are expected to increase by 1% to 2% at least each year to keep up with inflation.
How Much Should You Save?
While it can be challenging to pinpoint a specific number, especially considering inflation and rising tuition costs, one approach is to use the “one-third rule.” Financial aid expert Mark Kantrowitz explains: “Like any major expense in life, you can spread the cost over time, with one third coming from savings (past income), one third from current income, and one third from loans (future income).” With the “3x rule,” which states that the cost of college doubles over 17 years from birth to college enrollment, the one-third rule suggests that you should set your goal as the cost of college for four years in the year your child is born. You can take that number and divide it by the number of years remaining until your child starts college. This annual number can then be broken down into a monthly savings goal, which you can use to fund a college savings account. For example, to save for a child born in 2021 to attend an in-state public college, a parent might set their annual savings goal by dividing $88,720 by 17 ($5,218), and their monthly savings goal by dividing their annual goal by 12. This results in a monthly savings goal according to the one-third rule of about $435.
How to Start a College Fund for Your Child
You have several options available to start a college fund for your child. Here are some of the best ways to save for college using various funding options.
529 Accounts
A 529 account works similarly to a Roth IRA. It uses after-tax money to save for expenses in a tax-advantaged account. When it’s time for your child to use the money, there will be no taxes due as long as it is used for qualified education expenses. You have two options with a 529 account: a college savings plan or a prepaid tuition plan. Some states only offer college savings plans, while others offer both. In addition to tuition, college savings plans can be used for books, room and board, supplies, and equipment, such as computers and calculators. There are fees and costs (which vary by plan and state) associated with a 529 account, including enrollment fees, annual maintenance fees, fund expenses, and management fees. You can use a comparison tool to compare 529 accounts and the associated fees in your state.
Accounts
Cooperative Associations
The prepaid tuition plans are only available in some states and allow parents and grandparents to secure tuition rates for both public and private schools at today’s costs. Some prepaid tuition plans only cover tuition costs, and you can transfer the funds to a younger sibling if your child decides not to attend college. A 529 account comes with risks. What you can do with the funds is limited, and some prepaid tuition plans may not have any guarantee if the program fails. While you can enjoy tax benefits from funding a 529 account, there may be penalties if your child does not complete their degree or uses the funds for non-educational purposes.
Cooperative Accounts
You can also use a Roth IRA to save for your child’s college education. Traditionally, a Roth IRA is used for retirement funding, but it can be used for other purposes. Cooperative accounts are not as restrictive as 529 accounts, but you still use tax-deducted funds to finance the account, and distributions are tax-free. However, you should talk to a financial advisor to understand the implications of using a Roth IRA for your child’s education, including any penalties you might face if the funds are not used properly. On the bright side, if your child decides that they do not want to attend college, you can use that money for your own retirement.
Grants and Scholarships
Another way to tackle the high cost of college is through grants and scholarships. On average, your child can save about $7,310 for public college, $19,180 for a private nonprofit institution, and $21,560 for a private for-profit school. Many talented children have abundant opportunities to obtain grants and scholarships, reducing the amount of money you need to save in their college fund. In fact, there are scholarships available for students excelling in any extracurricular activity or hobby, regardless of how specialized it is. There are five million scholarships worth over $24 billion available to undergraduate students each year. To get an idea of the scope of available assistance, you can access multiple scholarship databases available for parents and children looking to save on college costs. It is acknowledged that searching for scholarships can be overwhelming. “Applying for scholarships can feel like a full-time job – we recommend applying for two to three scholarships per week, throughout the year, to increase your chances.”
UGMA and UTMA Accounts
UGMA and UTMA accounts (from the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act) are custodial savings accounts for children, which is another way to save college money. The account is in the child’s name, but a parent or grandparent is the custodian of the account and has control until the child reaches the age of majority in your state. There are no limits on the amount of money you can put into these savings accounts. The money can be used for expenses that directly benefit the child, including, but not limited to, college costs. The downside is that UGMA and UTMA accounts are reported on the FAFSA form, which can affect college financial aid eligibility. The account must be fully distributed by the child’s 30th birthday, and once they turn 18, the funds are theirs to do as they wish.
ESA Accounts
The Coverdell Education Savings Account is another option for a tax-advantaged trust account. The annual contribution limit is $2,000, and no contributions can be made after your child turns 18. Unlike UGMA and UTMA accounts, all funds must be used by age 30, but as long as they are used for education, withdrawals are tax-free. Unlike 529 plans, ESA funds can be used for primary and secondary education expenses in addition to college, as well as housing and food costs.
Trusts
Can
For parents and grandparents to create educational trusts to fund the education expenses of a designated beneficiary. These trusts are primarily used by parents or grandparents who have a high income as part of a tax planning strategy to limit taxable estate funds. All funds in the trust must be distributed by the beneficiary’s twenty-first birthday. These trusts are not commonly used, and many parents and grandparents find that a 529 account will suit their needs just as well.
Savings Accounts
You can use a traditional savings account for anything, including a college fund. There are no restrictions or limits on the amount you can deposit into the account. You can also withdraw the money at any time. It’s important to note that interest rates on savings accounts are lower than inflation, meaning you won’t have a growth that earns interest over the years, thus not maximizing your savings.
Working with a Financial Advisor
More than half of parents with children in tenth grade or higher wish they had saved more each month; the average amount saved is $200 per month. It’s worth noting that people with a financial advisor have saved about $14,000 more compared to parents without an advisor. A financial advisor can be a great resource when starting to save for your child’s college fund. They can help you navigate the many options available, including how to maximize your investments and make the most effective withdrawals when the time comes. When working with a financial advisor, they can put together a clear college plan for your child with manageable savings goals. If you plan to apply for grants, scholarships, or financial aid, the financial advisor can also assist you with this process and factor it into your college savings.
Originally published on October 6, 2021, at 9:00 AM Pacific Time.
By: Mandy Slait
Source: CNET
Source: https://www.cnet.com/personal-finance/investing/advice/how-to-save-for-your-childs-college-fund/
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