The short answer is… parents should start saving for college as soon as possible.
Nonetheless, figuring out how much to save for college and when to start can be confusing. The answers aren’t always crystal clear. However, saving for college is a massive undertaking that requires a strategic savings plan to reach your goals. If you’re working on your savings plan, you’re in the right place.
Here’s what parents should know about when to start saving for college, including the most important factor: beginning early.
The cost of college is rising every year. In fact, education expenses in the US have risen by over 180% since 1980. This makes an early savings plan not only useful but necessary.
Saving early gives you more time to contribute money and take advantage of compound interest — provided you invest the money. If you wait until the last minute to start saving for college, you’ll need to contribute a lot more. Likewise, the earlier you start investing college savings, the more time your money has to grow with interest.
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As enticing as it is to set aside money to grow, it’s vital that you are already financially secure.
Before looking into the future, you should always have an emergency fund, if possible. An emergency fund is intended for dire situations such as a natural disaster, unexpected job loss, or medical bills. In general, your emergency fund should equate to three to six months’ worth of your salary.
In addition to that, you should prioritize lowering any existing high-interest debts. While saving for college is important, the interest you’ll have to pay on debts might be more than what you can save.
That said, there are a few exceptions. For example, if you only have low-interest debt, it may be better to invest the money for college expenses. However, this takes serious time, planning and requires higher risk tolerances so it may not be suitable for all.
The current financial system provides a number of ways to start save for college. There are many instruments that are unique in their own regard, so understanding which to choose can be confusing.
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A 529 Plan offers federal and state tax benefits when used for educational expenses. A 529 Plan has restricted investment options. However, it’s a great choice because it can be used as a tax shelter while your money grows. In addition, these plans are considered parent assets, which means you don’t need to report them on the FAFSA.
Mutual funds create a diversified portfolio of individual investments —think bonds, stocks, or other securities. Unlike a 529 Plan, investing college savings in a mutual fund provides you with a bit more flexibility in terms of what you can invest in. That said, they are run by portfolio managers, who will usually charge a fee for their service. In addition, mutual funds are subject to annual income tax, and any money transferred to your child is viewed as income on the FAFSA.
Custodial accounts are brokerage accounts that you open on behalf of your child and then subsequently transfer to them once they reach 18, 21, or 25 years of age. Like mutual funds, the FAFSA considers custodial accounts as student assets, which can reduce your child’s financial aid eligibility.
Saving bonds are securities that are backed by the U.S. Government. They are one of the most risk-averse investments and safest options as you are guaranteed to get money back. Due to this guarantee, the rate of return for saving bonds is usually quite low, meaning that in periods of high inflation and higher costs, you may still end up losing money as the value of your dollar diminishes.
Some benefits of these vehicles include being federally tax-deferred and state-tax free. That said, the maximum amount you can invest is $10,000 on your own and $20,000 as a married couple per year.
With only 37% of the nation’s population using this type of account, Roth IRAs are underutilized but can provide a great investment strategy.
A Roth IRA is an investment account where you can earn tax-free interest on your contributions. While earnings are intended to be withdrawn once you are 59 years old, you can withdraw contributions prior to then with no taxes or penalties. There are no obligations or restrictions to when you withdraw and the FAFSA does not consider them assets. However, there are some downsides like the inability to invest more than $6,000 per year.
Regardless, all these options are great ways to start saving for college and growing your money to help with future college expenses. But what if you’re getting a late start on saving? Perhaps you weren’t able to invest right away? There are still many options available and the same principle applies, start as soon as you can.
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If you are starting late on saving for college, it may be smarter to take on less risk as market fluctuations can be a detrimental player to your college savings goal. Perhaps it would be wiser to look into more safe, secure investments or age-based plans.
If you don’t reach sufficient savings, you should look into the different types of financial aid for college. Additionally, you can use Sparrow to find the best parent student loan rates and compare across multiple lenders in minutes.
At the end of the day, saving for college should not put you in financial stress currently or in the future. Preparing a strategy to best manage your money and meet your goals is the best way to enjoy your financial future. Look at all the options available to you and talk your strategy out with a qualified financial advisor and your loved ones, as these financial decisions have great impact. Once you settle on a plan, don’t stress too much about the short-term and try to focus on the long-term advantages.
The content of this article is not, nor should it be, taken as financial advice. The content of this article is for educational purposes only. For personalized financial advice, please consult a financial or investment advisor.
