Saving for children’s college education is one of the prime most reasons why people start with long-term investments. Retirement and buying a house are other reasons for long-term financial planning.
If you have a new born or a young child then it is the right time to start saving for future college expenses. This is because time plays the most important role in determining how big your final corpus is. The power of compounding interest gives enough time for funds to grow and add value. So the most important thing that you need to do is start right away.
Since you have a clear goal in mind, planning your finances will not be very difficult. A good financial advisor will be able to take into account your needs and requirements, and based on your current financial situation will advise you how best you can save sufficient money by the time your little one is ready for college.
Here are a few tips to help you save sensibly, smartly and optimally for your long-term financial goal.
1) Save Systematically and on Auto Mode
Systematic saving is the wisest thing that you can do to save money over the years. There are many financial plans that help you do this.
You can set up a savings account at your bank or a credit union, or open a brokerage account. Set up automated transfers every month from your salary or checking account to the higher yielding savings account, money market deposit account or other investment purpose account.
Payroll savings plan allow automatic deductions from your salary into an account or investment vehicle of your choice. You can also choose to save with employer-sponsored account if one exists, and set regular deductions. It is possible to change the amount at any point in time or even stop the deductions and restart at a later period if you so desire.
Financial institutions and brokerage and mutual fund companies allow you to set up automated transfers between their various products like savings accounts and financial plans. Ensure you do your research well and choose a plan that best suits your purposes.
2) 529 Plans are Indispensable
529 plans are the most favored and popular educational savings plans where you can save regularly for your child’s future educational needs.
529 plans are savings plans that are offered by a state or an educational institution to enable families to systematically build a college education fund. Most states offer 529 plans and you can enroll your child in any eligible college within or outside the state. The plan is formulated to help meet college costs in institutions nationwide and your choice of plan does not usually limit the choices available to your student as to where he or she can study.
There are different types of 529 plans. You must choose one that is best suited to your long-term requirements. Broadly, 529 plans can be classified as savings plans or pre-paid plans.
Savings plans are very much similar to IRA or 401K where your regular contributions are invested in mutual funds or other investment vehicles. There are several investment options for you to choose from and your fund value will increase or decrease according to the performance of your chosen investments. If you are not satisfied with the performance of your 529 plan it is possible to switch investment options every 12 months.
Pre-paid plans let you lock in college costs at the prevailing rate and help bypass the ballooning effect of inflation. You will be able to fully or partly pre-pay for future tuition costs in an in-state public college of your choice. It is also possible to convert to out-of-state colleges or private colleges depending on your child’s choice.
In 529 plans after-tax money is invested for a specific period and the investment gains and withdrawals are tax-free. The money can be used towards meeting various college expenses. If your child does not opt for college, the withdrawals maybe taxed or you may have to pay fees or penalty. Alternatively, you can transfer the account to another beneficiary.
3) Roth IRA Can Be Leveraged
Roth IRA is a very popular retirement savings account, but it can also be used to save for future college costs. It is very similar to 529 plans in that you contribute after-tax money to the Roth IRA account and your contributions grow tax-free. You can make withdrawals from the account after the age of 59 1/2 to secure your golden years.
Roth IRA makes an exception to withdrawals used to fund educational needs. After a lock-in period of 5 years you can make tax and penalty-free withdrawals for qualifying college expenses.
The upside when compared to traditional 529 plans is that if your child does not attend college you can use the money as retirement corpus. The downside is that there are income and contribution limits to Roth IRA plans. The maximum contribution is $5,500 per year. If you are an individual earning more than $129,000 per year, or if you are a married couple with annual income more than $191,000, then you are not eligible to open a Roth IRA account. Roth IRA funds can also fund education in colleges and institutions abroad.
Another big positive as far as Roth IRA plans are considered is that it is not included as an asset under Free Application for Federal Student Aid (Fafsa) eligibility criteria, whereas 529 plans are. Free aid and other facilities like availability of free study book samples help offset financial burden on your child. So a 529 plan may inadvertently reduce the government educational aid that your child will qualify for in college.
4) Custodial Accounts Are an Option
You can open a bank account in your child’ name under Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA). You can deposit up to $10,000 every year in the account and the contributions are tax-free. You will be the custodian of the account till your child attains the age of majority.
When the child is a minor you can use the money in the account for any of your child’s needs. Once your child reaches the legal age of adulthood the account becomes his or her property, and the money can be used for whatever purpose your child chooses, education or not.
5) Gift of College Program
This is another great way to contribute towards your child’s college education fund.
Registration in the Gift of College program is free, and allows family and friends to chip in to your 529 college savings plan. You can create a profile for your child and encourage well-wishers to contribute to the program rather than spend on gifts and toys for your little one.
Birthdays, holidays and other special occasions become more rewarding when loved ones make a contribution towards securing your child’s future educational needs. This can make a hugely positive and long-lasting impact on your child’s life.
College is without doubt extremely expensive. But saving diligently and consistently will help you finance your child’s college costs at least partly. So make use of the luxury of time and power of compound interest, and start saving as early as possible.