Fact: the inflation rate on college tuition is outpacing that of the general economy — and financial aid isn’t keeping up. With a three-percent rise in 2015 on what’s already mouth-dropping higher education expenses, it’s no wonder parents everywhere are concerned over how to save for their kids’ college expenses — and why so many millennials are entering the workforce drowning in debt.
Whether you’re recently married and looking at the future or you’re already a parent, the time is now to start making smarter decisions that will lessen the burden on both you and your children down the line.
But where in the world do you begin? Take a deep breath and relax: We’re going to go through a few common mistakes made in college savings, the need-to-knows, and a brief introduction to a couple options for tax-advantaged savings plans that you can get started with today.
Common pitfalls in college savings that lead to a hectic future
Let’s start by looking at three overarching areas where those saving for college have typically gone astray before:
Starting too late: Simply put, it’s never too early to start saving for college. According to Financial Research Corporation, 34 percent of 529 saving accounts are started by parents whose children are between 5 and 10 years old. While this allows for a decent amount of time for money to grow, the “more the merrier” principle applies tenfold here, so starting to save at the very beginning, in most cases, is the best route to take.
Not understanding options for college savings: Like most things in the financial world, college savings accounts aren’t always cut-and-dry for those that don’t call financial planning their profession. The lack of education, though, often accounts for missteps early on. For example, many don’t open a 529 for their children because they don’t want to predict their educational future, not realizing that it’s possible to change beneficiaries to other family members, or to liquidate the plan and pay a small penalty and typical taxes.
Borrowing against existing assets: While you’ve built up other accounts for reasons of security, no doubt, it’s highly advisable that you don’t touch them unless you absolutely need to. When you borrow against your 401(k), for example, you not only put your eligibility for matching funds in jeopardy; you may inhibit your ability to change career positions without penalties. This is another area where educating yourself — or working with someone who knows — is essential to making the right move.
The need-to-knows when it comes to saving for your kids’ education
With the overarching pitfalls out in the open, let’s look at a few things you should know in order to make sound decisions:
The differences in tuition levels: While all higher education is relatively expensive, there are some options that make it much more affordable. Educate yourself on the difference between your in-state, public schools versus the private institutions that don’t receive federal or state monies and rely on grants and private investments. Out-of-state schools will incur different (higher) expenses. Knowing the differences can help you steer decision making and estimate what reasonably needs to be saved.
Merit-based scholarships versus needs-based grants or aid: Needs-based aid is awarded regardless of grades or achievements — it’s focused solely on the assets and income of the student and his/her family. Needs-based aid comes from federal funding (thereby requiring you to fill out a FAFSA to acquire), and is calculated by subtracting your expected family contribution (EFC) from the cost of attendance. Merit-based aid, on the other hand, is granted regardless of need and is instead based on academic achievement as well as other distinguishing factors like musical, artistic, or athletic ability.
What happens when you have multiple kids in college at one time: With two or more children in college simultaneously, EFC doesn’t change — but need will increase, often meaning that even if income and assets didn’t grant needs-based aid for your first child, it may for the second or third.
With a few major tenets in mind, let’s look at an abbreviated overview of plan options for college savings.
Tax-advantaged savings plans for higher education costs
Fortunately, there are a few options for college savings vehicles that allow you to put post-tax dollars in and later withdraw them tax free. Perhaps unfortunately, there are many more options within these vehicles that might make sense for you. Here’s a brief overview to get you started:
529 savings accounts: Named for the section of the Internal Revenue Code it was created under, a 529 allows money to accumulate and be withdrawn federally tax-free when put to use on education-related expenses. Minimums, maximums, fees, and returns will differ between states, but 529s have quickly become a popular option for college savings, and for good reason. A few benefits: the money can be transferred between beneficiaries (as mentioned above), are void of age or income limits when it comes to contributing, and are relatively low maintenance. One tip from USNews.com: To avoid the possibility of losing part of the American Opportunity Credit (for those eligible), don’t tap 529 plans until after paying the first $4,000 in qualified education expenses, such as tuition and textbooks.
Roth IRAs: A retirement vehicle used for college savings? Indeed. With a Roth IRA, the principal portion (the amount you contribute) can be withdrawn tax- and penalty-free at any time, for any purpose, granting you a bit more flexibility than a 529 plan. In addition, Roth IRA balances are not included in the calculations for estimated family contribution, while 529 balances are. Of course, because these aren’t designed for college savings like a 529 is, there are some downsides: the most pertinent one being that money beyond the principal cannot be withdrawn tax-free until the age of 59 ½.
Options are a-plenty when it comes to accounts. Choosing one shouldn’t be the barrier to getting started. Consult with a CERTIFIED FINANCIAL PLANNERTM professional to help you make the best decision based on your situation.
Getting your kids involved in saving
Another tactic we highly suggest you use in saving for your kids’ education: your kids, themselves. We are strong advocates when it comes to teaching your kids about investments early on, but we also encourage involving your kids in the savings process early on, through a few different means:
Teach them about mindful budgeting: Having your kids be privy to your own budget can help them understand how budgeting fits into lifestyle from early on. Be honest about limitations. Once they have discretionary income, help them to create a budget of their own.
Encourage them to get a job: One way to empower them with discretionary income? Encourage them to get a job as soon as they’re able. Not only does it encourage financial independence and teach responsibility, but students who work while in school also tend to have better time management skills and higher grades.
Keep junior/community college as an open option: Credits at a local, community college are a fraction of the price of those at a private university. Completing the first, general portion of a degree at a two-year institution can save tens of thousands of dollars — with other benefits as a bonus.
Help them to stay on track in school: This is not just important in high school, when they’re ripe for scholarships and grants, but also throughout college. Keep this in mind if you need incentive to help them: the fifth year of higher education increases costs by 20 percent, on average. Finishing on time doesn’t just make logical sense; it makes financial sense.
Enrolling your kids in your strategy for saving for their education offers them the opportunity to learn, to take responsibility, and to make better decisions as they grow.
The fun starts now
We said it before, but we’ll say it again: It’s never too early to start saving for your children’s college expenses. From this moment right up until they’re walking across that stage in cap and gown with degree in hand, college savings accounts can be built to help lessen the burden on you now, and your kids later.
As always, financial planning is easier with someone you trust on your side. The fee-only, CERTIFIED FINANCIAL PLANNERTM professionals at WorthPointe know college savings — and can help you get off on the right foot today. Contact us today to schedule a complimentary consultation.
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