How to Begin Saving for College
Life moves fast. And if you’re a new parent, or the parent of a young child, you might already be wondering about how to balance the new and ongoing costs of child-rearing with longer term milestones, such as college savings. As crazy as it may sound, there’s no better time than now to start planning. Costs of colleges and universities have risen dramatically over the past decade, ranging from 4-6% increases on an annual basis. If you’re thinking about sending your young child to your alma mater that costs $35,000 in today’s dollars, in 20 years, if the cost of admission continues to rise at the same rate, your alma mater would cost over $92,000 per year. Saving over the short run for this kind of investment is difficult, but with early planning, this is all very possible! In this week’s blog, we’ll demystify the process, and break it down into three achievable steps. Long-term saving takes commitment, but it shouldn’t feel stressful. Hopefully the paths we outline will help readers envision and take steps towards their own college savings journey.
Below are the three steps you can take now to begin saving for future education expenses
Step One: Decide how much you want to commit to paying for.
In order to begin saving for college, you need to think about how much of the costs you want to be responsible for. It’s understandable to want to strive for 100%, but that may not be realistic. As financial planners, we have seen every end of the spectrum -- some clients paid for their own college and want their children to do the same, some clients decide on a flat dollar amount as their contribution, and some want to plan on funding the complete costs associated with higher education expenses, regardless of where the child wants to go.
No matter your personal decision, you need to decide on some specific benchmarks in order to move on to the next step. To give you some insight on the costs of college today, we’ve drawn information from the College Board. If you decide that your child will be responsible for their tuition costs, it’s still important to consider savings benchmarks for their day-to-day living expenses during those years. If you aspire to cover a percentage of tuition, you will need to consider the type of school and program, and arrive at a dollar estimate to aim for. 100% coverage might be the simplest math (just multiply current tuition by the annual expected increase), but it will be the hardest to save for. Each choice involves tradeoffs in the present and future, and should be discussed with partners, family members, and any other financial stakeholders in your child’s life - including financial advisors.
In the event you decide that your student will be paying for some or all of their schooling, you can do additional research about how much they might be able to cover, based on what kind of financial aid is available. You might consider multiple scenarios, based on potential future achievements and scholarships. The main goal of this step is simply to arrive at a number that seems reasonable for everyone.
Step Two: Decide on the savings vehicle.
Once you have identified your savings benchmark, you can take concrete steps to consider various approaches to saving. Here are the two options we recommend:
1. A 529 Savings Plan: the focused and frugal choice
A 529 Savings Plan is named after Section 529 of the Internal Revenue Code (IRC). It is a tax-advantaged investment account, which is meant to encourage saving for future education expenses.
Pros:
This account is designed to fund education expenses. In fact, it can even be used for up to $10,000 of K-12 private school tuition per year.
You can contribute up to $15,000 per year per spouse to a 529 plan, gift tax free, with the option to frontload a plan for up to five years’ worth of contributions.
Single: $15,000 - $75,000 max annual contribution, gift tax free
Married: $30,000 - $150,000 max annual contribution, gift tax free
Any contributions made to this account will invest tax-free, and any withdrawals for qualifying educational purposes will be tax-free.
Certain states allow deductions of contributions on their state taxes.
A 529 plan beneficiary can be changed to a child’s parent, sibling, or even their own children in the event there are funds remaining after graduation.
Cons:
If there are leftover 529 plan funds with no eligible beneficiaries, you will pay income tax and a 10% penalty on the investment earnings portion of distributions.
You do not get to decide what is considered an eligible education expense
2. A Taxable Brokerage Account: the flexible and nuanced choice
A taxable brokerage account is a general investment account that can be opened at a financial institution. It is a lot less restrictive than a 529 Savings Plan or a traditional retirement plan, with no maximum annual contribution limit or eligibility rules for account distributions.
Pros:
There is flexibility with your contributions to a taxable brokerage account, as they do not have to be used for educational purposes. For example, you can save into a taxable brokerage account with a percentage or amount earmarked for education. If your child decides not to go to college, these funds could be used instead to fund retirement, a second home purchase, or whatever goal you have in mind-- penalty free.
There is no annual maximum contribution that can be made to a taxable brokerage account.
Cons:
You will pay capital gains tax on any investments sold to generate cash for education expenses.
However, working with a financial planner, we can help make the most tax-efficient decisions when it comes time to pay for school.
To sum things up, 529 plans were designed specially to pay for educational expenses. The main reason you would choose a taxable brokerage account over a 529 plan is if you prefer to have flexibility in your savings on the off-chance your child incurs no education expenses.
Step Three: Invest in your student.
When you make it this step, you can congratulate yourself! At last: you have made two of the toughest decisions for your child: how much you want to plan on paying for their educational expenses, and which type of account to open to achieve this. If you’re still struggling with steps one and two, remember that w with a financial planner can help you project additional future expenses, narrow down a dollar amount that would meet your funding goal, and determine the appropriate investment strategy for execution. No matter what, you’ll want to be consistent about your contributions, so depending on how your income and expenses are structured, you may want to set up recurring contributions either monthly, quarterly, or annually.
This step is also a great place to open the door to money conversations with your family. We’ve seen many parents, grandparents, aunts and uncles who want to contribute, but don’t know how. 529 Plans make gifting very easy, but this can also be done in a structured way through the taxable brokerage account. The important thing is that contributors stay within the $15,000 per year gift limit per person (otherwise, your relative will want to file a gift tax return). Remember - this is $15,000 per person, so if your mother and father would like to contribute to your child’s education, they could do so up to $30,000 per year.
When you’re ready to start investing, remember that this is a commitment to your child’s present and future. Consider it another daily expense - mundane but critical to success. And finally, as a general rule, the earlier you can contribute larger amounts, the faster you will reach your long term goals. Try to let unexpected contributions from family or bonuses accelerate the process, rather than distract from your routine. In all cases, be kind to yourself and be proud of whatever you can afford to do. Any savings plan is a loving act of care for your family’s well being.
How Mana Can Help
We honor that the details of these steps and associated conversations will be challenging, and will likely spark many tough questions for first-time parent planners. Financial planning is all about trade-offs and the trickiest part of that balance involves saving and preparing for your short term needs vs. your long term goals. Know that at Mana we are here to help! We value our job as brainstorming partners, and look forward to empowering you to achieve your education funding goals.
Allison is an Associate Financial Planner at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. Allison focuses on the financial planning process, which brings client visions to life through their finances.