Sallie Mae has tracked the main reasons given for why parents are saving less for their child’s college education and lack of disposable income is the main culprit.
The increasing cost of utilities, gas, and food are all contributing to the lower disposable income for mom and dad and the reason why they are putting less into a savings account for college. We will discuss some strategies you can use to help jump-start a savings plan for your child’s college education.
Reasons for Decline in College Savings
Saving for college is a simple matter of dollars and cents and very often it is one of the hardest things to get started. Oftentimes parents get overwhelmed with having to pay for day-to-day expenses and when it comes time to think about putting away 10 percent of their income into a savings account, it just doesn’t get done.
If that sounds like you, then change your goals to be more reasonable and attainable based on your current circumstances. If you can only save 2 percent of your income a month, then start with that amount and you can always adjust it later. Lowering your expectations a bit can lessen the stress you may be putting on yourself to save as much money as possible.
Setting unreasonable goals is the first reason for the decline in college savings. The other is finding the money to put into the account in the first place. If you have worked up a budget so you know where all of your money is going each month, look for some places where you can cut back to make a little extra money available.
For instance, do you really need to spend $200 on cable TV each month, $80 a month for a pool maintenance person, or $100 month on Starbucks coffee? Making some little adjustments to your spending habits can put a little extra money into a college savings account. You will be surprised at places you can cut back and you will not even miss these things once they are gone.
Where to Put Your Money
Now that you have a reasonable goal for your monthly contribution, you now need to put the money into a place where it will grow the fastest. Recent statistics show about half of American families that are saving for college use a general savings account. Just 27 percent utilize a tax-advantaged account, like a 529 college savings plan. Let’s go over some options you have when it comes to saving money for college tuition.
The 529 plans are a great way to save for college for the same reason your 401(k) plan is a great way to save for retirement. Namely, income tax savings. Like a qualified retirement plan, earnings in these plans grow tax-free. Every state offers some type of 529 plan, either a college savings plan, prepaid tuition plan, or both.
Unlike your 401(k) at work, there’s no federal tax deduction for 529 contributions. But two-thirds of states offer a state tax deduction for residents and these six states, Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania, offer a tax break for any state’s plan.
College Savings Plans
These plans are very similar to tax-advantaged retirement plans, such as 401(k)s. You put in as much as you’re allowed, choose an investment option, then hope your contributions earn enough to meet your needs when college rolls around. Earnings are tax-free if used for any qualified college expense, including tuition, fees, and room and board. If one kid ends up skipping college, you can substitute a sibling, or even use the money for yourself if you go back to college.
Drawbacks: If you end up not using the money you put away in a 529 plan, you won’t lose it. But you will pay a 10 percent penalty and income taxes on the earnings (not the principal) for any non-education withdrawal. So you want to be fairly sure someone in the family will ultimately go to college.
Another drawback is that these plans are also not very flexible. Investment options are limited and can typically only be changed or transferred to another plan once a year.
Tips: If you live in a state with income taxes, you’ll obviously want to use your state’s plan if it offers a state tax deduction. If you’re able to shop around among various states, however, look for plans with low expenses. As with your 401(k), low expenses mean higher earnings.
Prepaid Tuition Plans
A college savings account is simply a tax-advantaged place to accumulate money for a specific purpose. Also like retirement plans, there’s no guarantee that when the date arrives to use those savings, they’ll be enough. But a prepaid tuition program eliminates that doubt by guaranteeing that if you deposit today’s tuition, it will pay the future tuition, no matter what happens.
There are two types of prepaid tuition plans: those offered by states, designed to pay the tuition of in-state public universities, and those offered by private colleges.
- State plans are designed to pay the tuition for public schools within a specific state.
- Prepaid tuition plans sponsored by specific private universities. You can check them out here.
What does a Roth IRA have to do with funding an education? Another provision of these accounts is that you can withdraw your original investment before retirement age without incurring a penalty. Roth rules allow you to withdraw your original investment to pay for your child’s education without penalty.
When it comes to which of these savings options is best, each one has advantages and drawbacks. They all depend on factors such as where you live, your income, and your ability to save. No matter what you decide, the most important thing you can do is start early and make your contributions automatic. That’s the best way to increase your odds of saving enough and get there as painlessly as possible.