Whether your child is six weeks old, or 16 years old, it's not too early - or too late - to plan for college expenses. By setting strategy now, you'll be in a better position to help your child come up with the necessary funds to pay for college when the time comes.
In this page, we would like to give you some information about the financial planning steps you can take to be prepared for what's ahead. You'll want to consult with us before using any of the planning tools and strategies we discuss here.
If your child goes away to college, you'll also have room and board expenses. A student living at home will have commuting expenses to and from campus. In addition, most colleges have student activity fees, some courses may have lab or other extra fees, and certain programs may require students to buy special equipment, such as a laptop computer. To these costs, add miscellaneous expenses such as the cost of furnishing and outfitting a dorm room and spending money. Fortunately, parents have more control over these expenses than over other college costs.
Current And Future Costs
Now that you have an idea of what you'll be paying for, the big question is how much will it cost? The following survey results from the College Board, a national nonprofit organization, show the cost of attending different types of colleges during the 2004-2005 school year.
And these costs will keep rising with inflation.
It's never too early to start investing for a child's college education. The sooner you start, the more time your money has to potentially benefit from the power of compound growth, which is growth on top of growth. If the money you invest grows, then your original investment plus its new value can grow again, which means your money may grow at a surprising pace. For an example, a $100 monthly investment with 8% yield will have $18,761 interest accumulation besides the principal of $18,800. That is a 100% growth. Time is money.
If you want to keep up with rising college costs, you should try to invest for growth. Historically, stocks have offered the best chance for your money to grow over the long term. If college is 10 or more years away, consider investing primarily in stocks and/or stock mutual funds. Then, gradually move those funds to more conservative holdings as your child nears college age.
Is it ever too late to start?
What if you've put off saving and college is only a couple of years away for your child? Should you skip saving altogether and hope for financial aid or fall back on loans? Not necessarily — saving late is better than not saving at all. Remember, college costs don't arrive all at once; they trickle in over four years (at least). Even if you wait until the last minute, you still have an opportunity to invest for college. If you're in this situation, you'll want to consider investments with a shorter time horizon.
The first part of your strategy: choosing the right account for you
The government has created two accounts — 529 plans and Education Savings Accounts (also known as Coverdells) — to help you save for your children's college education. These accounts provide many advantages over custodial accounts, general brokerage accounts and savings accounts.
A 529 plan is a state-sponsored program that allows parents, relatives and friends to invest for a child's college education. Generally, you can choose from a selection of age-based or static investment portfolios that are professionally managed by the program's fund manager. The account belongs to you, not your child, and any potential earnings grow tax deferred. What's more, you pay no federal taxes on earnings as long as you withdraw the money to pay for qualified educational expenses.
529 plans don't limit how much you can contribute per year. Instead, they have a lifetime contribution limit (often greater than $200,000) per beneficiary that varies by state.
An Education Savings Account is managed by you on behalf of your child. You can invest the money you contribute to an ESA in stocks, bonds, or mutual funds. Whatever you're comfortable with. When your child turns 18, you can choose to hand over the reins or continue managing the account yourself.
ESAs provide tax advantages similar to 529 plans: Your money grows tax free and you pay no taxes on earnings if you withdraw the money to pay for qualified educational expenses. However, ESAs can be used for certain elementary or secondary school expenses as well as for college expenses. You can contribute a maximum of $2,000 annually, if you qualify.
A custodial account is an account managed by a parent or guardian on behalf of a child. The money belongs irrevocably to the child, so if you're managing a custodial account for your daughter, when she turns 18, 21 or 25 (depending on the state rules governing the account) she can use the money for anything she wants — a new car or a European vacation, for instance.
Custodial accounts offer minor tax advantages, and have no restrictions on how the money can be spent, as long as it's for the benefit of the child. If you want to set aside money for expenses that aren't covered by an ESA or 529 plan — sorority dues or private voice lessons, for example — a custodial account may be just the thing.
You can use a brokerage account to invest for college, but it offers no tax advantages. A 529 plan, an ESA or even a custodial account is probably a better choice. However, supplementing your tax-advantaged college investments with a taxable brokerage account sometimes makes sense for example, if you want to save money for non-qualified college expenses and maintain control of the money. A savings account may be a place to put away a few dollars for a rainy day, but it's a poor choice for college savings. Savings accounts usually don't even keep up with inflation, much less rising college costs.
The second part of your strategy: when and how to invest your money
Eighteen years before college
• Open the account of your choice and contribute money every month, perhaps by signing up for an automatic investment plan. Contribute extra money whenever possible.
• If appropriate given your risk tolerance, invest the money in stocks or mutual funds for long-term growth.
Eight to 10 years before college
• Has anything changed in your life? A new baby? A better-paying job? Consider these changes and recalculate your needs.
• If you haven't yet opened an account, do so right away. You may want to go with a 529 plan, which allows much larger lump sum contributions and may give you a chance to make up for lost time.
• Contribute any windfall money to your college savings account.
One to two years before college
• Figure out your expected family contribution, a number that financial aid officers use to help evaluate your child's eligibility for financial aid.
• Look into your options for financial aid and scholarships.
• Reassess the risk level in your accounts. As college approaches, consider moving the money into less risky investments, such as shorter-term bonds and money market funds.
Contact us for obtaining more information on 529 plan or educational savings plan. Start today to prepare for your child's future!
© 2014 Michael J. Porro & Company