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FEBRUARY 2023

Saving for your kids’ college education

A NerdWallet survey found that 1 in 5 parents of children under age 18 haven’t started saving for their children’s college education but want to. If you’re a parent who knows you need to start building your child’s college education fund but haven’t gotten started yet, here’s how to begin.

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Consider opening a tax-advantaged account

529 account

When choosing an account for college savings, look into tax-advantaged options. One such option is a 529 account, which is specifically designed to save for education expenses. A 529 account allows your savings to grow tax-free, and some states even offer a tax deduction on your contributions.

The downside of a 529 account is that if you withdraw funds for anything other than qualified education expenses, you’ll be penalized. There’s also the risk that you won’t need the funds for education at all – though you can change a 529 beneficiary to another family member or even yourself for qualified education expenses if your child decides not to go to college. There are also limited investment options with a 529.

Roth IRA

Another savings option is a Roth IRA, which is traditionally used as a retirement account, with earnings that grow tax-free. Contributions to a Roth IRA are limited to $6,500 a year — $7,500 if age 50 or older — for the 2023 tax year.¹ There are also income restrictions and contributions which can’t exceed earned income. So, unless your child earns money, you’ll have to use your own Roth IRA to save for your kids’ college education.

Contributions to a Roth IRA can be withdrawn at any time, but earnings are usually subject to a penalty if you withdraw them before you turn 59 ½ years of age. If you made the first contribution to your Roth IRA at least five years before, you could also withdraw the growth for qualified education expenses. The benefit of using a Roth IRA over a 529 account is flexibility. If your child doesn’t go to college, you can leave the savings in the Roth IRA for your retirement. Also, you have more investment options.

Start saving consistently, no matter how much

The average tuition cost at a public four-year in-state university is $9,377 in 2022-23, according to the Education Data Initiative. (The average tuition at a four-year private, non-profit college is $54,501.) If your child is young, this will likely be much higher when they’re ready for college. Costs will be higher still if they don’t live at home and need to pay for room and board.

While teens are thinking about getting into their “dream school”, they may not be thinking about what the student loan debt will do to their lives in 20 or 30 years. According to Dave Ramsey of Ramsey Solutions, student loan debt has become part of culture and is accepted as a normal part of life. The financial loan crisis, which is also referred to as a “Borrowed Future”, is drawing national attention and negatively affecting people and our economy.

While earning a college education isn’t everyone’s dream, it can be overwhelming to think about how much your child will need to pay for college, but the best thing you can give your money is time to grow. That means putting some money away on a regular basis, even if it feels like a drop in the bucket, and starting as soon as possible.

Let’s say you deposit an initial $200, then save $50 per month from birth through age 18. By the end of that time, you’ve contributed $11,000, but when you include modest investment returns of 5%, you’ll have $18,025 saved. That may not be enough to cover four years of college, but it can make an impact. And that’s assuming your savings rate doesn’t increase.

You can use an investment return calculator to see how college savings can grow over time.

Make a plan for extra money in your budget

Over time, you’ll probably find extra money in your budget that could boost college savings, like a tax refund or merit raise. Child care costs will also likely diminish or go away as your child ages, lowering your fixed expenses. Plan early to use some of these funds to save more for college.

Perhaps you want to put one-quarter of any windfall into college savings, or you decide to reallocate funds that previously went toward child care into their 529 account. The details don’t matter, but you’ll want to make these plans before the money is in hand. Otherwise, extra funds have a way of allocating themselves.

Don’t compromise your retirement for college savings

The NerdWallet survey also found that nearly 3 in 10 parents of children under 18 who have personal student loan debt (29%) prioritize saving for their kids’ education over saving for retirement. While it makes sense that parents want to keep student loan debt from burdening their children, retirement savings need to come first. Student loans are an option if your child needs them, but you can’t take out loans to cover your expenses in retirement.

Look into ways to cut costs before applications start

You don’t need to wait until your child’s junior year of high school to start thinking about how to keep college costs reasonable. Talk to your child early about how much you can afford to contribute to their education and the steps they can take to limit student loan debt. This could mean starting out at a two-year college, choosing an in-state school and applying for scholarships.

¹The Motley Fool. Roth IRA contribution limits in 2023 are better than ever.

Sources: NerdWallet. How to start saving for your kids’ college.
Ramseysolutions.com. What No One Told You About Student Loans, Podcast series.