College Savings 101
Paying your child's tuition can seem like a daunting task, but deliberate planning can make it possible.Kathy Longo, CFP®, CAP®, CDFA® Monday, 21 September 2020
College expenses always seem to be on the rise, so tackling college savings can feel like a herculean task at times. Accumulated College Board data for the 2019-2020 academic year showed an average cost of $21,950 as an in-state student at a state school, and a massive $49,870 for a private school. A bit of math easily reveals that four years at any college or university will cost a pretty penny, especially if your children aren’t close to college age just yet. In fact, tuition is likely to continue rising at a rate of about 8 percent each year, and assuming cost trends continue, parents and prospective students will face steep tuition bills in the future.
While not all parents are able to or want to pay for their child’s entire college education, many feel it’s important to contribute at least partially if they can. With rather alarming annual increases in costs, however, parents who wish to help put their children through college need to start planning and saving now. As with any large financial burden, the more time you spend saving, the lower the financial burden is at any given time.
Looking at the Numbers
Using the 8 percent annual increase mentioned above, we can estimate that your child’s college education will cost $112,058 for four years at a state school, and $254,593 at a private school. Of course, since many students take longer than four years to graduate, costs can easily be greater.
Looking further out, the dollar figures are even steeper for college students ten years from now. If your child enters college a decade from now, it will cost $143,018 for a state school education and $324,932 for a private school education.
Are you looking even further into the future? If your child is currently a toddler and won’t enter college until fifteen years from now, they can expect to pay $182,528 for four years at a state school and $414,704 – nearly half a million dollars – for four years of education at a private school. This is why it’s crucial for you to implement a savings plan as soon as you can so that you can begin saving immediately and take advantage of the magic of compounding.
Additional Cost Factors
While the tuition numbers alone can feel overwhelming, they don’t tell the whole story. Financially planning for your child’s college education means planning for a plethora of additional fees and expenses, too. You’ll have to think about rent or room and board, depending on whether your child lives on campus, plus things like gas money or plane tickets for trips home, textbooks and technology supplies. You should also consider grocery or meal plan costs.
Before you can put a savings plan into place, you first must determine the costs of any of these extraneous factors and add them to your child’s projected need. Once you’ve calculated how much money must be saved, you can then determine whether either of the below savings plans will work for you.
Option 1: The Coverdell Educational IRA
A Coverdell Education savings account or a Coverdell ESA is a trust or custodial account set up for the sole purpose of covering qualified educational expenses – whether collegiate, elementary or secondary, for the designated beneficiary of the account. The beneficiary can also use this money to purchase scholastic materials such as computer equipment, internet access, or other educational related services.
This is a great choice for many people, though there are some regulations to be aware of. At the time of establishment, the beneficiary must be under the age of 18 and the account must be designated as a Coverdell ESA. Furthermore, any contributions made into this account must be made in cash and those deposits are not deductible. While there are no limits to the number of accounts a beneficiary may have, there is a cap at $2,000 per child and the annual combined contributions from all ESA accounts cannot exceed that limit.
Should the beneficiary take out any distributions which are not meant for qualified education expenses, those withdrawals are subject to income taxes as well as a 10 percent tax penalty. If the account ends up being unnecessary, the beneficiary can transfer the account to another family member without any tax penalty. However, upon the beneficiary’s 30th birthday, if the account hasn’t been used or transferred, the money leftover becomes taxable and is distributed to the beneficiary.
Option 2: The 529 Plan
Another popular college savings option is the 529 plan. This plan is a qualified, state-sponsored, tax-deferred program created specifically for college savings, which you would open up in your name with the beneficiary being your child (or any other student you’re planning to help put through college). You can find at least one 529 plan in nearly every state, though they all differ slightly, and you can choose any state’s plan regardless of whether you reside there.
One major benefit of a 529 is that it includes enhanced gift and estate tax benefits. You’re also allowed to make larger contributions than you can with a Coverdell ESA. Upon opening the account, you can make a contribution of up to $75,000 per beneficiary or $150,000 if a couple is funding the 529 plan without triggering the gift tax. This means you can reduce the taxable value of your estate while simultaneously supporting your college savings plan.
All funds saved in a 529 account are earmarked for educational costs including room and board and books, so using the money for other expenses will usually mean incurring a penalty from the IRS. So long as your 529 satisfies some basic requirements, federal tax law provides special tax benefits that could ultimately benefit you even further. The U.S. Securities and Exchange Commission offers a great primer about those benefits here.
The Key Factor: Just Begin
Whether you’re planning on covering the full expense of college for your child or hoping to cover a partial amount, the key is to begin. Say you have a baby at home and determine a savings goal of $237,000 for them to attend a public college in 18 years; assuming an average 7 percent annual return, this goal could be accomplished with a monthly contribution of $550 – as long as you start now.
The two savings options mentioned above are common, but they aren’t right for everyone and this isn’t an exhaustive list. If you feel like neither of these will suit your needs, please reach out so that we can have a more nuanced conversation about your individual circumstances.
No matter where you fall on the spectrum of how much financial aid you plan to provide for your future college student, it’s important to remember to take care of yourself first. Though college can take up a lot of emotional and mental energy, it’s best to prioritize your retirement over your children’s college expenses. With the right plan in place, both of these goals can be accomplished, especially if you’re working alongside a financial advisor who can guide you as you build and execute your plans.
Family is extremely important to me, and I know how strong the need can be to want to help your children accomplish their biggest dreams. Contact me today to learn more about how I can use my professional experience and vision to help you build a college savings plan that aligns with the rest of your financial and personal goals, as well.
About the Author
Kathy Longo brings over 25 years of expertise and experience to Flourish Wealth Management. Kathy is wholly dedicated to improving the life of each client and finds joy in making complex matters simple and easy to understand. She excels at asking the right questions, uncovering new possibilities and implementing the most advantageous strategies for success. Playing such a pivotal role in her clients’ lives remains an honor and a privilege. After earning a degree in Financial Planning and Counseling from Purdue University, she began her career at a small firm in Palatine, Illinois where she worked directly with clients while learning to build a viable, client-centric business. Over the years, she gained extensive knowledge and wisdom working as a wealth manager, financial planner, firm manager and business owner at notable, various sized companies in both Chicago and Minneapolis.