Start Saving Early to Pay for College
Just as getting into college consumes the waking hours of many teens, paying for it becomes an obsession for parents.
According to a survey from Fidelity Investments, 76 percent of parents figure they will have to dole out money for their children's college education -- and 43 percent think they will have to put off retiring to put a kid through college first.
But, by starting out early with a savings plan, you can give your children a future without comprising your own.
It's never too early to start saving for your child's college education -- even if that child hasn't been born yet, says Adam Bashe, former managing director of Futuretrust, a college savings program by Destination Maternity Corp.Money is the second-biggest worry expecting parents have -- after their baby's health, Bashe says. But many parents are unaware that there are programs to help them, including accounts that give tax breaks on money saved for their kids' education, such as 529 and Coverdell accounts. Bashe says his research shows nearly 50 percent of parents don't know about 529 plans.
The 529 plans, named for the section of the Internal Revenue Service Code that created them in 1996, are state-run programs that allow parents to set aside money for college. The gains on 529s are protected from federal taxes and, in some cases, you also can get a state tax break, such as a deduction on your state income tax.
You're not limited to investing in your home state's 529, so you can shop around for more attractive plans in other states. Many investment websites offer tools that let you compare the various state plans available.
Many parents wait to open 529 accounts because they think their kid needs a Social Security number, but that's wrong, Bashe says. Parents can open the account themselves before the baby is born and transfer it to their child's name later, he explains.
The 529s have stolen the thunder of the older Coverdell Education Savings Accounts -- once known as "Education IRAs." These accounts also allow parents to set aside money tax-free, and most withdrawals are tax-free as well, such as a standard Individual Retirement Account. Coverdells have the advantage of letting parents use the cash to fund private school tuition, not just college.
But Coverdells have more restrictions than 529s: The amount parents can put aside is currently capped at $2,000 a year, and the accounts are not transferable. The balance is returned to the child if it's not used for education, so things can get tricky if your kids decide they don't want to go to college, after all.
Parents who have more maneuvering room in their finances also can set up savings or investment accounts for their kids under the Uniform Gift to Minors Act or Uniform Transfer to Minors Act. The IRS lets parents give certain amounts of cash to their kids every year as tax-free gifts. The money is held in a trust account until the child is 18 or 21, depending on the state. But so-called UGMA/UTMA accounts have the same downside as the Coverdells: Once the kid is old enough to receive the funds, parents have no say over what they do with them.
The 529 plans, on the other hand, allow for the money go to another family member, so Bashe recommends front-loading your firstborn's 529, so the gains can pile up before the expenses of raising more children can reduce your ability to set aside money. Then, as your children begin college, you can roll over money from one child's account to the next.
Just like IRAs, most college savings plans have small minimum investment requirements, so you can open one with a few dollars. The College Savings Plans Network, part of the National Association of State Treasurers, has a site with information on what 529 plans are and how they work, and lets you compare the plans in your state and shop for plans in other states.
Regardless of which type of account you choose, it's important to put away something -- whatever you can afford -- and keep adding to your account regularly, either on your own or via automatic deductions from your paycheck or bank accounts. Some college savings accounts have features that link to programs such as Upromise, and let parents automatically roll over credit card, banking and shopping rebates into the college fund, so you can build up the college funds with your household spending.
Bashe also recommends reviewing the college fund once a year and increasing the contribution, especially when the family's income increases, such as when a parent goes back to work full-time or either parent gets a raise.
"If it's $25, the next time you can't go to $50, but you go to $40 or $35. It's a move in the right direction," he says.
Bashe invokes the magic of compound interest -- simply put, the gains on the amounts you already contributed rack up some more gains and help your savings grow faster with time. If you start early, even $25 a month can add up to real money in 18 years.
"No matter what you can afford, starting is important," he says. "Not starting is the problem."
Related: Plan Ahead When Saving for College
Start by teaching him that it is safe to do so.