College savings - Facts and tips for parents
, by Rob Kaufman
You know the saying, "The early bird catches the worm". Well, when it comes to saving for college, the same idea holds true, but it's more like, "The early bird catches financial peace of mind".
It may seem as though your child's college years are light years away, but time goes quickly and the last thing you want is to be caught financially unprepared for your child's education. (Okay, it might not be the last thing you want, but it's probably close.) So how do we stop that from happening? Read on...
Where to start.
Once you create a budget and know how much money you have to put away each month, you need to decide the best savings vehicle for the education fund. You do have a number of alternatives from which to choose and all ultimately depend on your financial situation, risk tolerance and time horizon.
- Coverdell Education Accounts (CEAs) are investment accounts that offer parents tax-free growth on the investments along with tax-free withdrawals, providing fund are used for qualified educational expenses.
A major benefit of this type of account is that unlike other educational accounts, there are virtually zero restrictions on how you can invest the money. More options means greater profit potential. Plus, if the situation requires, this money can also be used for Kindergarten through High School education. (i.e. Private high school.)
The downside to CEAs is that there are age limits for the beneficiary and there are yearly and income-based restrictions put in place. This is why it's important to compare education accounts before deciding which way to go.
- Custodial Accounts are also investment accounts that you can set up as a college fund of sorts. The best thing about a custodial account is that there are no restrictions to how much you can invest or what kind of investment strategy you want to use.
The potential negative aspects to this kind of account is that they are taxed and the beneficiary has total control over the account once he or she reaches the state's "adult" age. That could mean that the fund might not be used for educational purposes.
- 529 plan is the plan of choice for parents looking for an investment that grows tax-free until it is withdrawn and when the money is used to pay qualified college expenses, the growth is taxed to the student (low tax bracket).
These are state plans and each plan is unique in its own way. A great benefit of the 529 plan is that it doesn't matter the state in which you live, you can get a plan from any state. (Currently, the only states with plans that don't offer 529 deductions are: CA, DE, HI, KY, MN, NC, NJ, NH and MA.) This enables you to compare state plans and see which one(s) work best for you.
Some states manage the funds within their own agencies while others have investment firms (i.e. Merrill Lynch, Charles Schwab, etc.) develop and manage the investment portfolios. When comparing 529 plans, make certain that you are aware of the following:
Risk vs. potential return of the plan's investments
Age or education expense restrictions
Ease of changing beneficiary, account owner or getting out of the plan
Two important notes: if you contribute to a 529 plan, you can't also contribute to a Coverdell for the same beneficiary. However, a 529 plan lets you contribute $100,000 or more for each child no matter age or income level, so it should be able to cover your needs.
Getting a late start.
Okay, so what if you weren't in a financial position to save for college and now your child is a teenager? Is it too late to start saving?
It's never too late to start saving money. However, with funds being scarce and college just a few years away, there are other avenues you should consider. First consider where your child will go to school. Can it be a local or community college so you can save money on room, board and other "distant" school expenses? When you start comparing schools, you'll see that some state and second-tier private schools provide just as good an education as the more expensive universities.
Once you've decided where your child can go to school, do extensive research on and scholarships. These monetary benefits can be provided by the government and the chosen university. Check online, call the university, and check with your child's high school advisors. If there's a way to get financial assistance, a lot of digging can help you find it. And remember to check your FICO Score before applying for loans so that you can be sure that your interest rate isn't higher than it should be.
Although it's a few years before your child attends college, he or she will be graduating which is when repayment of loans and other financial aid you received might have to begin. Figure out how much you can start putting away now to help pay those bills when they come in. As you've already seen, time flies. It's time to prepare for when that time arrives.
See how much you might have to budget for college expenses with the myFICO College Living Expense calculator. It's a great place to start your research!