Important Factors to Consider While Planning for Your Child’s College Education
Like all other parents, you would want your child to have a good education and a successful future. For this purpose, you work hard, juggle family schedules, make time for their homework, and do so much more, only to prepare them to take advantage of different life opportunities. The most important foundation of a secure future is education. However, a college education can be outrageously expensive in America. A financial advisor can partner with you to help evaluate your options and develop an education savings plan to optimize your savings.
As per U.S. News, over the last 20 years, the in-state tuition and fees for public universities in the U.S. have increased by 212%. The out-of-state tuition and fees for public schools have also shot up by 165%. Likewise, private colleges have recorded a rise of 144% in the past 20 years. Further, as per a survey by Fidelity, most parents wish to sponsor at least 65% of their kid’s total cost for college. However, many of these parents have savings to only cover 33% of their target.
Even though the numbers are alarming, there is still hope. You can easily save a significant corpus for your child, even if you have a restricted budget, provided you create a comprehensive plan for education expenses.
Here are the most important factors you should consider:
1. Determine your needs for your child’s education to set a savings target
The first step in education planning is to know and acknowledge your needs. For this purpose, ask yourself a few basic questions:
- How many children do you have or plan to have in the future?
- How many years do you have before they begin college?
- Where do you want your child to study? Public or private colleges? In-or out-of-state?
- Do you have a specific school or stream you want your child to study?
- Will your child continue studying for four years?
- Do you expect your child to go to grad school?
Once you have the answer to these questions, it will be easier for you to set a savings target. To know how much to save, research the projected costs for college as per your preferences and answers to the questions above. For instance, if you wish to send your child to a top private university, you would likely need to save more than a parent who has plans to send their child to a public university.
2. Do not compromise your own financial situation while saving for your child’s education
Once you know your savings target, set a realistic goal and begin your education planning journey. The objective is to simultaneously plan for college costs without jeopardizing your personal financial situation. Even though, as parents, it is natural for you to place your child’s needs before your own, you should ideally not compromise on important financial plans, such as retirement. You can easily borrow for college but borrowing for retirement is tricky and comes with several complications and tax-related issues. The ideal way to go about this is to first align your financial plan. Focus on paying off your pending credit card bills and avoid taking any high-interest debt. It is also advisable to set aside an emergency corpus for the future. Ideally, your emergency fund should be three to six months’ worth of your living expenses. Lastly, stay on track and save for your retirement. All these steps will ensure you do not burden your kids with your living expenses later only because you failed to build a nest egg for your retired years.
3. Know when to start saving and planning for your child’s education
Time is your greatest asset when it comes to education planning. As per the College Board, a four-year public college for an in-state student will annually cost around $26,820, a four-year public college for an out-of-state student will be nearly $43,280. For private colleges, as per the same parameters, you can expect to pay as high as $54,880 per year. Keeping these numbers in mind, it is never too early to start planning for your child’s education. Irrespective of whether your child or grandchild is just born or is a toddler, the right time to begin saving for their education is now! If you start education planning at a young age, you allow your money more time to grow over the long term. This also means that in case there are any dips or losses, you have a considerably longer time horizon to absorb the losses and rebound. In addition, when you start saving early, you can easily reduce the amount you have to borrow if needed. You can begin saving a small amount initially and gradually increase your savings rate. Even a small portion that you set aside can make a big difference in helping you meet your child’s future’s needs. The best method to do this is to automate your savings. Planning early also gives you time to assess if your child will qualify for scholarships. Moreover, the money you save affects the financial aid your child qualifies for in the future.
4. Choose wise mediums to save for their education
The most common mistake parents make while planning for their child’s education is keeping their money in a savings account. Even though it might seem like a safe option because it is protected from market volatility, it erodes the value of your money in the long run. This way, you end up losing money eventually. This is because even the best of savings accounts that offer high interest rates cannot keep up with the pace of inflation. As per statistics, college costs rise at about two times the general rate of inflation each year. This trend will likely continue in the future too. As per the College Savings Plans Network, the parents of a toddler in 2021 will require $244,667.00 by the time the child is ready for higher education to cover the costs of an in-state, public college for four years. In a private college, the cost will be $553,064. Hence, it is vital to choose the right method to save for your child’s education. You can consider using the following mediums:
- 529 college plans: 529 plans are state-sponsored, tax-advantaged plans that allow you to invest after-tax dollars to save for your child’s higher education. The money you contribute is invested in secure bonds and low-cost stocks to garner effective but safe returns in the long run. The account allows your funds to grow tax-free, and your withdrawals are also exempt from taxes, provided they are used to pay for qualified education expenses like tuition, room, boarding, books, etc. If the money is used for non-qualified expenses, a 10% penalty is charged. Each state has different rules for a 529 college plan. You can choose to invest in your state or another state’s 529 education plan, depending on the benefits. Further, you also have the freedom to change the designated beneficiary in the future to cater to another child’s education. Moreover, there is no annual limitation on contributions. But the balance of your 529 account cannot be more than the anticipated fee of qualified higher education. However, you must evaluate your qualified expenses and be cautious with the 529 withdrawal rules. If possible, apply well-in-advance for the withdrawal.
- 529 prepaid tuition plans: 529 prepaid tuition plans are also another way to pay for your child’s education in the future. These plans help you cover the tuition fees for your child, which is the most draining educational expense. In a 529 prepaid plan, you can pay all or a part of, the costs of education (of a specific university or a group of institutions) in advance. This will help you avoid the future rise in tuition prices, which are expected to jump by 5% each year. 529 prepaid plans have no income or age limits and offer tax–free growth with high contribution rates. Like 529 college plans, you have the flexibility to choose and change the beneficiary in the future to benefit another child or even yourself. However, this plan can become ineligible if your child does not go to college or receives a full scholarship. In such a case, you have an option to change the beneficiary or pay a 10% penalty to withdraw the balance.
- Coverdell education savings account: You can also use the Coverdell education savings account to save for your child’s education. The Coverdell plan functions like a tax-deferred trust. You can contribute after-tax dollars in this account to pay for your child’s college, elementary as well as secondary education Your funds grow tax-free and you do not pay any taxes at the time of withdrawals. However, the distributions from your Coverdell savings plan can only pay for qualified educational outlays. The scope of qualified expenses in this plan is wider than the 529 college savings plan. The Coverdell education savings accounts allow tax-free withdrawals for primary and secondary school tuition, uniforms, tutoring, and other K-12 charges. You also get an extensive assortment of investments to pick from, compared to a 529 plan. However, you can only save $2,000 in this account annually until the recipient is 18 years.
- Roth IRA: Apart from using your Roth IRA (Individual Retirement Account) to save for retirement, you can also use it for education planning. In a Roth IRA, you can save after-tax dollars, earn tax-free growth, and get tax-free withdrawals. This triple-tax benefit makes a Roth IRA a wise choice to plan for your golden years as well as pay for your child’s education. A Roth IRA offers higher flexibility and significant tax benefits as compared to other retirement accounts. Moreover, unlike other retirement accounts, such as a 401(k), there are no Required Minimum Distributions (RMDs) in a Roth IRA. However, you cannot withdraw your funds before the age of 59.5. This means your savings accumulate interest for a longer time horizon. But when it comes to paying for your child’s education expenses, this restriction on withdrawal can cause a hassle. It is possible to overcome this drawback through effective time management. You can use other accounts to cover education fees initially and deploy Roth IRA funds for higher education expenses later. Roth IRA provides you with a wider investment basket and gives you the liberty to use your funds as per your choice, unlike other plans like 529 college savings plans, 529 prepaid plans, and Coverdell education savings accounts. For 2021, you can contribute up to $6,000 in your Roth IRA. If you are 50 years or older, you can invest up to $7000 annually. For contributions above these limits, you will incur a penalty of 6% for every year until the fault is corrected.
Apart from these mediums, you can also consider putting your money in a custodial account such as UGMAs and UTMAs (Uniform Gift to Minors Act and Uniform Transfers to Minors Act). Alternatively, you can invest in mutual funds, set up a trust, take a permanent life insurance plan, or consider taking a home equity loan, if needed, to fund your child’s education expenses.
5. Involve your children in planning for their higher education
If your child is in high school or college, you can consider discussing education expenses with them easily. If your children understand the financial values of their college funding decisions, it will help them make better choices.For instance, if you have taken a loan to pay for your child’s education, it is good to keep your children informed. The college your child chooses or the field of study they opt for has a big influence on their salaries, and in turn, their loan repaying abilities. Moreover, this will help your children understand the implications of borrowing and might encourage them to shoulder some responsibility for their choices. As per a study conducted by the College Savings Foundation in 2019, 89% of the students plan to work to manage their college costs. Most students do not expect their parents to bear the financial brunt of their education alone and want to accept the charge for funding their education.
To sum it up
If you wish to give your child the gift of good education without burdening them with student debt, you may want to start planning for their education as soon as possible. Consult a professional financial advisor to know the right way to pay for your child’s education without saddling your finances or compromising your own financial goals.