Your child may not be enrolling till 2028, but you need to start saving now. We'll help you pick a plan that won't bust your budget.
If you're like most parents with young kids, opening a college fund is on your to-do list (right below joining a gym and scheduling a date night), but you haven't actually done anything about it. You've got some good excuses. Between caring for the kids and running the household, you barely have a free minute to check your e-mail. Your budget is stretched thin by diapers, baby gear, and, well, you name it. And the numbers aren't exactly encouraging: If college costs continue climbing at more than 5 percent annually, the price tag for four years at a public university will rise to about $105,000 by the time your baby matriculates -- and $275,000 if she goes to a private institution.
But take a deep breath. The fact is that few families end up paying the whole bill for higher education. Two thirds of undergraduates received some form of financial aid during the 2007-08 school year, according to the College Board, a nonprofit association of colleges and universities. A more realistic goal for middle-class families is to try to save about one third of the projected college cost, notes Mark Kantrowitz, founder of finaid.org, a financial-aid site. Direct aid, scholarships, student loans, and your income at the time your child applies for school can make up the rest.
Plus, if you start now you can build a sizable nest egg. "My advice is to contribute what you can as early as you can," says Jerry Cannizzaro, a certified financial planner in Oakton, Virginia. Even a small investment can pay off big-time when college rolls around (and trust us, it will happen a lot sooner than you think). Follow these steps to painless saving.
First, learn a bit about 529s.
For most families, 529 college savings plans, which are sponsored by individual states, are the easiest way to save. You can open an account by making a contribution of as little as $25 per month. As with a Roth IRA, the money in your account grows tax-deferred. Once your child starts college, you can withdraw money tax-free to pay for tuition, room, board, books, and supplies at any accredited institution.
To sweeten the deal, 35 state 529 plans offer generous tax incentives. In New York, a couple can deduct up to $10,000 annually in contributions per household, which could save more than $600 in state taxes. While many states have a limit on tax deductibility, Colorado, South Carolina, West Virginia, and New Mexico have no cap. If you live in Arizona, Kansas, Missouri, Maine, or Pennsylvania, you'll get a tax break even if you choose to join another state's plan. A dozen states even match contributions for low- to moderate-income households; Arkansas families with an adjusted gross income below $60,000 and a child under age 7, for instance, may qualify for a $500 annual grant.
Another benefit: "The assets in a 529 have only a negligible effect on financial aid eligibility because they're treated as your assets, and not your child's," points out Joe Hurley, president of savingforcollege.com, a college guide for families.
Still, you should be aware of the potential 529 pitfalls. If your child doesn't attend college, you could be subject to income tax plus a 10 percent penalty on the earnings withdrawn. You'll also owe Uncle Sam if your child earns a full scholarship (we should all be so lucky). 529s also tend to offer fewer investment choices than IRAs, and you're generally limited to shifting the assets once a year. But for busy parents, that may not be the worst thing.
Then select the best plan for your needs.
While it makes sense to look at what your state is offering first, you may prefer to shop around for a 529 with lower fees or better returns. Visit savingforcollege.com to compare the many options. Double-check that any out-of-state plan you're considering allows nonresidents to join (most do). Look at the range of investments, note the management fee (look for a number below .42 percent, the industry average). Go to morningstar.com/529 to see how the funds have performed relative to their peers. And stick with plans that are sold directly so you don't have to pay a broker. Confused? This should help: We've highlighted four of the best (see page 6 of this story).
Prepaid tuition plans, which let you contribute toward your child's public in-state education in today's dollars, are another 529 option. However, they've become problematic in recent years, as states have faced rising tuition costs and deficits. "Most prepaid plans have stopped accepting enrollment, or increased their prices well beyond current tuition costs," says Hurley. One exception: The Independent 529 Plan (independent529plan.org) welcomes new participants and lets you prepay toward 274 participating colleges. Admission, alas, isn't guaranteed.
Next, choose your investment approach.
Most 529s let you pick among a number of different mutual funds (which invest in stocks, bonds, and other securities) and offer portfolios to match your risk tolerance, whether you're conservative, aggressive, or some-where in between. There's also a popular hands-off alternative that works well for most parents: picking an age-based portfolio, in which your asset allocation changes automatically, from stock-heavy holdings when your child is young to a less-risky balance as he gets closer to college age. Before selecting this option, though, you should examine how the money is divvied up at the beginning and end of the age spectrum. "Every plan handles these portfolios a little differently," says Hurley. "So it's important to make sure you have the same idea about risk."
Finally, start saving.
Now comes the hard part: actually socking away the money. It doesn't have to be, though. Simply set up automatic contributions from your bank account or through direct deposit from your paycheck (check to see if your employer offers this service). "By doing it that way, and slowly increasing the amount you put in as your salary increases, you won't really miss it," says Cheryl Costa, a certified financial planner in Natick, Massachusetts. Maybe that's because before long you'll also see the money working for you: A $100 monthly contribution earning an 8 percent average return will add up to $48,000 in about 18 years.
It's also a good idea to solicit funds from your parents if they're in a position to help out. According to a survey by The Hartford Financial Services Group Inc., 65 percent of grandparents want to help their grandkids pay for college, and over half plan to donate more than $10,000. If your folks or in-laws have expressed interest in starting a college fund, gently suggest that they refrain from opening a savings account in your child's name (explain that it could hurt your chances for financial aid down the road). Instead, ask them to write you a check earmarked for your child's 529 plan or open a new 529 account with your child as the beneficiary (kids can have multiple accounts in their name).
If they haven't mentioned it yet, no worries. They're probably too busy taking baby pictures or buying little gifts for every visit. So feel free to bring it up, tactfully. "When they ask what your child needs for a birthday or the holidays, say, 'A check for her college fund would be terrific,'" says Costa, who went so far as to ask her parents to sign up for a Fidelity rewards credit card that links to her kids' 529 accounts. Between her spending and theirs, they've accrued about $8,000 toward Matt, Eric, and Christina's education.
Once you get going, you'll find that your college savings account can grow even faster than your child. And when diapers become a thing of the past, you'll be glad you planned ahead.
Plans That Make the Grade
Ohio College Advantage
Indiana College Choice 529 Direct Savings Plan
Utah Educational Savings Plan
Virginia College Savings Plan
Not convinced a traditional college plan is the right move? Try these out-of-the-box alternatives.
Open a Roth IRA
This retirement plan lets you contribute up to $5,000 in after-tax dollars annually, and the money grows tax-free. You can't touch the earnings till age 591/2, but you can withdraw the principal when that first tuition bill arrives.
Pay off your mortgage
If you can afford higher monthly payments, refinance to a 15-year mortgage. It'll let you own your home out-right by the time your child goes to college. Then write a monthly check for tuition instead of one to the bank.
Buy universal life insurance
This policy doubles as an investment: A portion of your premium goes to tax-deferred holdings. When it's time for college you can withdraw contributions, reduce coverage, or borrow against your plan.
Invest in a state municipal bond fund
These funds are averaging a 4 to 6 percent return, and as long as you pick one that buys bonds in the state of your residence, it's tax-free too. Plus, you can use the money as you please.
Originally published in the June 2010 issue of Parents magazine.