How To Save For Your Kid’s College

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SAVING FOR YOUR CHILD’S COLLEGE

How do we save for our kid’s college?

Ah. One of the many questions most of us ask ourselves once we have kids.

Shortly after our son was born, we took a stroll down Van Ness in San Francisco to Chase Bank.

We plopped ourselves down in two of their office chairs while Micah was fidgeting around in his stroller and said, “We would like to open a college savings account for our son.”

The nice bank lady explained a few things to us and asked some questions and when all was said and done, a college savings account was opened with his name on it. We patted ourselves on our backs and off we went.

But, the truth is this, we had absolutely no clue what a college savings account really was. 

We just knew that we should be contributing money here and there so that when he is ready to go to college, he will have a sum of money to pursue “higher education.”

Fast forward 3 years. We are now a one income family. I started looking into our financial situation.

I was researching online, digging out bank statements, and logging into every single financial account we have. I was learning a boat-load of finance stuff and one of them was…yes the college savings plan.

This is what I learned.

How to save for your child's college

1 | HOW TO PAY FOR COLLEGE?

  • You may choose to save a certain percentage of the estimated total cost of tuition & expense (anywhere from 1-100%). We will figure out how to get an estimate of the total cost of tuition below.
  • You may choose not to save now and help pay for college when they are actually going.
  • You may choose not to save and if your child decides to go to college, they can apply for financial aid and scholarships, work part-time, and pay for their own college tuition & expense or take out a loan.
  • Or you can do a little bit of all the above.

Now, to figure out how to save for college we need to know TWO things.

  1. How much should we save?
  2. Where to put the money?

2 | HOW MUCH SHOULD WE SAVE?

Most of us know that student loan debt here in the U.S. is no joke. It is the second highest debt, right behind mortgages. It is a 1.5 TRILLION dollar crisis (read here).

Many parents are saving up money while their children are young and hope that these savings can help them when they go to college.

Now, we won’t be able to know exactly how much to save, but we can certainly get a good estimate.

We also don’t know exactly which college they will choose to attend and where they will be accepted but we can narrow down some choices.

We can look up the attendance cost of any public, private or religious, and even some international colleges and universities right here on our screen. Thank you, Google.

Let’s look up one together now.

For example:

Let’s say we live in North Carolina and we intend to stay here permanently and hope that little Johnny (3 years old) will choose UNC after he graduates high school. We have not started his college savings yet.

STEP 1:

Go to UNC’s website under Admissions and Undergraduate Admissions, we find this right here:

Cost of attendance for the 2018-2019 school year will be roughly $24K (rounded up) assuming you are a North Carolina resident with no financial aid or scholarships.

Cost of Attendance

STEP 2:

Adjust the cost of attendance with tuition inflation. Johnny is 3 years old in 2018 so we still have approximately 15 more years before Johnny goes to college. We have to find out how much college will be when he turns 18 in 2033.

Using an online college tuition calculator by Vanguard*, we plug in our numbers.

  • Years until college: 15 (Johnny has 15 years until college).
  • Years in college: 4 (we will assume that he will do his whole undergrad there).
  • Rate of annual cost increase: 5% (this is the tuition inflation rate** and it’s pre-filled at 5%. You can change it if you want).
  • Current annual college cost: $24,000 (which is the number provided by UNC’s website, rounded up).
  • Click Calculate results.

*There are other college tuition calculators out there you can google and play around with. You can also use the same calculator and look up the cost of other colleges and universities. Click “Look up cost” located next to “Current annual college cost.”

**The tuition inflation rate may vary depending on your source, I’ve seen anywhere from 3-5% (pretty high). If you are interested in that you can read here and here.

College Tuition Projector

STEP 3:

After you click “Calculate results”, you will see this below (hover over the graph bars to see the numbers):

College Tuition 1 Year
College Tuition 4 Years

STEP 4:

Figure out how much to save.

Recap: The cost of attendance for 2018-2019 in UNC (assuming you are NC resident with no financial aid and scholarships) is around $24K. After adjusting $24K to a 5% tuition inflation, we are looking at $49,894 per year or $215,050 for 4 years (insert eyes-popping emoji).

This means you will need to save roughly $215,050 between the year 2018 and 2033. So, we take $215,050 and divide that by 15 (years ’till college) and we get $14,337.

We have to save $14,337 per year (or $1,195 per month)for 15 years in order to pay for Johnny’s undergrad.

MINIMIZE THE COST

Now if you are like me, you may be thinking, “Johnny better apply for financial aid and scholarships and he is definitely working part-time.

Also, if you look closely at the costs, you have some “indirect costs.” Johnny can buy used books and minimize his travel & personal costs. He can choose to live off campus. All of these will most likely drive down the cost of tuition and you can adjust your college savings plan accordingly.

HOW TO GET AN ESTIMATE FOR FINANCIAL AID ELIGIBILITY

You can use FAFSA4caster, a tool (not an application) to get a free early estimate of your child’s eligibility for financial aid and this will give you a better estimate of how much to save for college. 

You can look up some scholarships here but you probably won’t have an estimate until your child applies.

Now that we have an estimate of how much we should be saving, we need to find a place to stash the cash.

3 | WHERE TO PUT THE MONEY

We have several options here.

  • 529 Plan
  • Coverdell Education Savings Account (ESA)
  • UTMA/UGMA
  • Savings account
  • IRA & Roth IRA
  • Brokerage account

529 PLAN

WHAT IS IT?

  • There are two types of 529:
  1. Prepaid tuition plans: Units or credits you can buy from participating college or universities for future tuition and fees at today’s price. Here is a list by state.
  2. Education savings plans: More popular of the two 529 plans. Basically, these are tax-advantaged investment accounts for education. You can find all 529 savings plans by state here.

ELIGIBILITY

  • Almost anyone can open a 529 account on behalf of the beneficiary.
  • There is no income limit for owners. High-income earners are eligible.

WHAT ARE THE BENEFITS?

  • Money grows tax-free.
  • Withdraw tax-free (up to $10,000 per year, per beneficiary) as long as the money is used on qualified education expense.
  • Some states offer tax breaks if you are a resident.
  • You can also use this for K-12 school tuition and expense (public, private, or religious). But, not for homeschool. Bummer.
  • You can transfer to another child, yourself or your spouse, first cousins, the list is actually pretty generous. For the complete list: See IRS Publication 970, Chapter 8, Page 53.
  • No age limitations to open a 529, meaning you can open one for a minor or an adult.
  • Money can be distributed at any age.

WHAT IS THE CONTRIBUTION LIMIT?

The IRS states that “contributions cannot exceed the amount necessary for qualified higher education expense.” Also, there is a gift tax rule over $14,000 per year ($28,000 for married filing jointly).

IS THERE A MINIMUM CONTRIBUTION?

The minimum contribution depends on each fund.

HOW TO APPLY?

Here is a list of direct-sold 529 plans provided by nerdwallet.com. You can click on each state’s 529 plan and it will direct you to the plan’s website. Browse the website, talk to an advisor if needed, usually, you can apply online.

WILL IT AFFECT FINANCIAL AID?

Yes, it will. Read more here.

HELPFUL LINKS ON 529 PLANS

ADVICE*

  • Direct-sold will usually be cheaper than broker-sold. It is what we chose.
  • This is what I would consider when choosing a fund.
    • Determine how you want to invest. Aggressive, moderate, or conservative.
    • Look at the returns, expense ratio, and fees of each fund.

FOR EXAMPLE:

Let’s say I choose the PA 529 plan from Pennsylvania. I would:

  1. Go to the plan’s website.
  2. Search for a list of funds available in their investment plan
  3. Check out the returns
  4. Note the expense ratio.

The higher the returns, the better. The lower the expense ratio, the better. Obviously, these are investments so nothing is guaranteed, you are taking a risk anytime you invest your money.

The expense ratio is the cost they charge, usually annually, to manage your fund. It may seem like a small amount but this is important because if you are holding the fund over a long period of time it will add up. Here is a simple video I found that does a good job of explaining it.

*Disclaimer: We do own a 529 and I try to keep myself updated. HOWEVER, I am not a 529 advisor, please call up the 529 plan that you are interested in and consult with their financial advisors and your own judgment before committing. 

COVERDELL EDUCATION SAVINGS ACCOUNT (ESA)

WHAT IS IT?

Think Roth IRA, but for education.

ELIGIBILITY

  • The beneficiary has to be under 18 unless they are special needs, otherwise, there’s a penalty if you contribute after he/she turns 18.
  • Eligibility depends on your modified adjusted gross income (MAGI). As of 2018, you can contribute if your income is less than $110K for single filers and $220K for married filing jointly, this may or may not change in the upcoming years.
  • Once the beneficiary reaches the age of 30, you must distribute the money for qualified education expense or transfer to a family member of the beneficiary who is under 30 (read here).

WHAT ARE THE BENEFITS?

  • Money grows tax-free.
  • Withdraw tax-free, as long as the distribution does not exceed qualified education expense for the year.
  • The beneficiary can be your child or a neighbor (that’s right you don’t have to be related).
  • Can be used for homeschool if your state defines homeschool as a type of private school (read here).

WHAT IS THE CONTRIBUTION LIMIT?

  • The maximum total contribution is $2,000 per year, per beneficiary. A penalty will apply if you contribute more than that.

IS THERE A MINIMUM CONTRIBUTION?

The minimum contribution depends on each fund.

HOW TO APPLY?

Here is a list of providers compiled by savingforcollege.com. You could also go through a broker from certain financial institutions that offer IRAs (call or visit their website).

WILL IT AFFECT FINANCIAL AID?

Yes. Read here.

HELPFUL LINKS

NOTE

  • I would look over the funds just like I would for a 529 (example above).
  • Cash contributions only and it is irrevocable.
  • You can contribute to both a 529 plan AND Coverdell ESA.

UTMA/UGMA

WHAT IS IT?

Uniform Transfer to Minors Act (UTMA) and Uniform Gift to Minors Act (UGMA) are custodial accounts. Meaning an adult has custody over the account until the minor becomes an adult, ages 18-21 depending on which state you live in.

There’s no major difference between the two, certain states offer UTMA and certain states offer UGMA and they differ in the kinds of asset you can contribute. Here you can contribute more than just cash. Depending on which UGMA/UTMA account you have, you may be able to contribute insurance policies, real estate, as well as cash or mutual funds.

ELIGIBILITY

  • Any adult can open a UTMA or UGMA for a minor.
  • No income limit for custodians.

WHAT ARE THE BENEFITS?

  • Not just limited to education. Money can be used for anything to the child’s (or beneficiary’s benefit).
  • The child can also contribute to his or her own account.

WHAT IS THE CONTRIBUTION LIMIT?

None, but if the child has a total of $2,100 or more, it will be subject to the kiddie tax. Also, contributions more than $15,000 per year (or $30,000 for married filing jointly) will incur a gift tax.

IS THERE A MINIMUM CONTRIBUTION?

Yes, it depends on each fund.

HOW TO APPLY?

Many banks or investment financial institutions offer UTMA/UGMA.

WILL IT AFFECT FINANCIAL AID?

Yes. Since UGMA/UTMA is considered the child’s asset it will weigh heavily on your child’s financial aid application. Usually up to 20%.

BE AWARE

  • You cannot change the beneficiary.
  • Once the child (or beneficiary) reaches adulthood (18-21), the asset is in his/her control.
  • Contributions are considered “irrevocable” gifts. Meaning you can’t take the money back.
  • The tax portion of UGMA/UTMA makes me cringe. You can read here from the IRS on how a child’s investments and unearned income will be taxed. I also found this article on how the 2017 Tax Act affects UTMA/UGMA if you are interested. I would definitely consult a tax advisor if you are unclear.

HELPFUL LINKS

SAVINGS ACCOUNT

Using a savings account for college savings is an option. However, with interest rates so low in most traditional brick and mortar banks, I would hesitate.

If you insist on using one, I would recommend online savings account like Ally. Ally’s interest rate is currently (at the time of this writing) 2.00%, no minimum balance.

You can look into CDs (Certificate of Deposit) while you are at it since this is for college you may not be needing the money anytime soon, rates for CDs are usually higher but most require a minimum balance.

No tax advantages here. But, if you are looking for flexibility and are not ready to invest, a savings account is worth looking into.

IRA & ROTH IRA

Yes, you can use your IRA or Roth IRA for qualified higher education expense for yourself, spouse, dependents, and grandchildren.

However, I would be very cautious.

IRA and Roth IRAs are intended for retirement and while the rule is that you can take out money for qualified higher education expense without incurring the 10% penalty, there are some things you should be aware of and I would read the most current and up-to-date IRS Publication 970, chapter 9 very carefully (2017 is the most current at the time of this writing) and consult a tax advisor if needed.

BROKERAGE ACCOUNT

You can also open a brokerage account and earmark it for your child’s college savings. Now, of course, there are no tax advantages, but there is flexibility.

Meaning, if your child receives a full ride to Harvard (hallelujah) or decides not to go to college (nothing wrong with that) and there’s no need to pay for his/her college tuition and expense then you can simply use this money for anything else.

4 | HOW ARE WE SAVING FOR OUR KIDS’ COLLEGE?

Kids College Savings

While we do have a 529 plan and will be earmarking a portion of our brokerage for their college savings, we are currently not setting aside a certain percentage towards their college savings fund.

We tend to contribute a small amount each year and any Christmas or birthday money they receive from friends and family go straight to their college savings fund.

It is not because we don’t care about their college savings.

We are prioritizing where our savings go and at this point in our lives, saving for a home and retirement is higher up on the list.

Once we’ve reached our goals, we will most likely funnel a portion of our savings to their college fund.

Also, we prefer that the kids apply for financial aid and scholarship and work for their college education. That’s what I did.

We also plan to contribute as needed once we know they are in college and are needing legitimate help.

HOW WILL YOU SAVE?

As you can see, there are plenty of options when it comes to saving for college.

So, tell me below in the comments section how will you be saving for your child’s college? I am curious!

See you next time!

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