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Saving for a Child's College Education


 

Military parents understand the importance of saving for a child's college education. However, with college tuition rising steadily, many of them have no idea how much money they must save in order to pay for college in the future. To stay ahead of increasing costs, it's more important than ever to begin saving early and to have smart saving strategies.

How much to save

Even if your child won't be starting college for more than a decade, it will help to get a rough estimate of how much money you'll need to put away. You can use average tuition costs, published by organizations such as the U.S. Department of Education College Affordability and Transparency Center, which includes several lists of institutions based on the tuition and fees and net prices (the price of attendance after considering all grant and scholarship aid) charged to students.

Once you have that figure, use the national average rate of increase to get a good estimate of what college is likely to cost when it's time for your child to attend. Public university tuitions rose an average of eight percent in 2011, and private universities have historically increased tuitions an average of about six percent per year. Here's an example: Let's say you just had a child this year and would like her to attend a four-year college that costs $10,000 per year today. If that college's costs inflate at an average of 7.5 percent per year, you'll need $147,032 by the time your child is 18 to pay for all four years.

If the idea of saving $147,032 seems impossible to you, you're not alone. Many parents feel the same way and aim to save only half of the amount of college costs and expect the rest of the money to come from loans, scholarships, work/study, student earnings and family income. In fact, 75 percent of all students attending four-year schools do receive some sort of financial aid, but you'll still need to save money to cover costs that financial aid doesn't cover.

Ways to save and invest

To develop an effective savings strategy, it's important to have a goal that allows you to watch your progress. The key to any savings plan is compounding interest. This means that even if you put away a small amount of money, if you leave it alone for a long period of time, it will start working for you by earning interest. Therefore, if you start as early as possible and then adjust your plan as the time for college draws closer, you'll be making the most of your savings.

You can set up a college fund through any number of investment options offered by banks and investment companies. In many cases, you can contribute through payroll deductions or automatic bank withdrawals, which makes saving even easier. Keep in mind that if your college savings strategy includes borrowing against a retirement savings plan such as a 401(k), 403(b) or Roth IRA, be sure you can pay it back and afford the loss of interest income on your retirement savings for a while.

Before you establish a college savings plan using a traditional investment option such as a mutual fund, you need to understand tax-advantaged tuition savings programs authorized by Congress and individual states.

Coverdell Education Savings Accounts

Formerly known as the Education IRA, the Coverdell ESA currently lets individuals save up to $2,000 per year per child for educational expenses. Anyone - grandparents, aunts, or cousins - can contribute to one of these savings plans as long as their income doesn't restrict investments. Coverdell ESA funds can be withdrawn on a tax-free basis for education purposes, and you don't have to pay taxes on your investment earnings either. However, if you withdraw funds beyond what you're allowed to use for education expenses, you may pay a tax penalty.

Coverdell ESAs are not the quickest way to save money, but if you faithfully contribute the maximum amount each year starting when your child is very young, you will end up with substantial savings. If you decide to open a Coverdell account, remember that you may not be able to participate in other savings plans at the same time and that you may not rollover 401(k) or Roth IRA accounts into a Coverdell ESA. Banks and investment companies can give you more information about opening an ESA.

Qualified Tuition Programs (529 plans)

These state-run plans named after Section 529 of the Internal Revenue Code have become very popular in recent years. Not every state offers a qualified tuition program, or QTP, but more and more are beginning to roll them out. The two types of QTPs include prepaid tuition programs and college savings programs, but both are also referred to as Section 529 plans.

  • Prepaid tuition plans allow parents to lock in at today's tuition rates and are an excellent idea for families who are fairly certain their child will attend a state school. It's important to remember, however, that participation in a prepaid plan is not a guarantee of admission; your child will still have to be accepted at the school where he or she applies. Prepaid tuition plans are simple, low-risk plans allowing contributors to pay for amounts of education - years or units - at a fixed rate. Contributions to these plans are usually subject to federal taxes when redeemed, but the taxes are imposed at the student's rate, not the parents' rate. Some state taxes may be entirely waived when the plan is redeemed. Investments can be made through one-time lump sum purchases or monthly installments. If your child ends up going to a private college or an out-of-state college, some states will refund your payment without interest; others will transfer funds to other state plans and, in some cases, private schools.
  • College savings programs are state-sponsored investment programs designed to help families save for college with the help of generous tax benefits and fewer restrictions than other plans. Contributions to these programs generally grow entirely tax-free, and about half the states offer tax deductions for contributions. These savings accounts can be used to pay for education expenses, including tuition, room and board and books, at any accredited university or college in the country. Accounts grow tax-free, and investors are usually allowed to roll over their account into a different state's program or change options within the plan once a year. It's also usually easy to change the beneficiary of the account. For example, if the original beneficiary decides not to go to college, the account can be transferred to another qualified family member without penalties.

Each state has a different Section 529 savings program, and many of them are open to people from other states. Fees, tax benefits and restrictions also vary, so it's important to shop around for the best plan for your needs. Talk to a financial planner who is familiar with Section 529 plans to get additional assistance.

Savings and financial aid

College savings do sometimes affect financial aid awards, particularly when it comes to private grant awards. However, financial aid offers include fewer grants these days and instead rely more heavily on loans. Because grants are less common, parents can't count on their availability. By saving for college instead of counting on financial aid, parents could be disqualifying themselves from some grant aid, but they are almost certainly ensuring that they and their child will have to take out less in student loans and pay less in interest. Also, be sure to find out about scholarships, grants and loans specifically for military children. See the Military OneSource article "Tuition Help for Military Children."

Savings strategies

Once you decide how you'll save for college, the key is sticking with the plan. Every little bit that you can invest in your savings will help you in the future by earning more in interest. Here are some ideas for making saving easier:

  • Use automatic withdrawal. An automatic withdrawal plan from a bank account or paycheck places money in a desired account, whether it's a 401(k), a mutual fund or a Section 529 savings plan. You don't have to do it yourself, and you don't have the option to put it off.
  • Make contributions to your savings a regular part of paying bills. Treat your savings plan as you would a bill that has to be paid. When you sit down to pay the bills, make the first check you write a deposit to your investment fund, rather than waiting to see if any money is left over after you've paid the other bills.
  • Allow your strategy to change over time. Investment strategies should evolve and change over time. If possible, you should try to contribute to funds that are more aggressive in the early years. As your child approaches college age (and bill-paying time), choose more conservative investments.
  • Start now. Once you begin saving, you'll be surprised how quickly your money adds up over the years. Whether your child is an infant, a preteen or even a teen, the best time to begin saving for a college education is now.

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