Determine the objective that will best serve you, and then get moving.
When it comes to paying for college, getting started earlier rather than later is optimal. However, getting started can be extremely challenging. The cost of attending college is rising; since 1980, the cost of attending college has increased at a rate significantly greater than the overall basket of goods and services that people typically purchase.
In addition, there are a variety of other factors that need to be planned for. Which type of university—public or private—should you attend? Should you remain in the state, or should you travel to another state? Is it possible for your child to receive financial aid? What about postgraduate study?
You are in luck since it is not necessary to have all these questions answered before you can begin saving money. The following are some of the most beneficial ways that can be used to determine how much money should be saved for college.
Pick a Destination as Your Aim.
The anticipated expense of attending college is a frequent basis for one of the most prevalent types of financial goals people create for themselves. It is helpful to begin by using one of the calculators that are available to help you estimate the cost of college for your child.
These calculators take into account a variety of factors, including the age of your child, the type of school you anticipate your child will attend, and the rate at which the cost of college is expected to increase.
You should also think about whether or not your child has already expressed an interest in attending a certain school, to which you already have access to this information.
Are you experiencing some sticker shock? The good news is that regardless of whether you are putting money away for in-state, out-of-state, or private tuition, you do not need to plan for the total cost.
Instead, financial planners may suggest setting aside between one-third and half of the total cost of college, with the hope that the remainder will come from financial aid, scholarships, and the present income of the student and/or parent.
Having a goal that is both practical and attainable, such as saving money for college, can be facilitated by this.
Take, for instance, the scenario in which you have recently become a parent and are eager to initiate a savings plan. Your final goal maybe $44,753 for a public school in your state, $69,346 for a public school outside of your state, or $112,072 for a private school. This will cover one-third of the estimated total cost of college.
Establishing the Appropriate Monthly Objective
Is it too impossible to imagine what the final objective will look like a few decades from now? You might want to think about working it out as a monthly donation amount.
Just keep in mind that the manner in which you save money will have a significant influence on the total amount that you will have saved by the time your child begins college.
The use of a 529 college savings plan, which is a tax-advantaged investment account, comes highly recommended by a variety of knowledgeable individuals.
A 529 plan provides tax-free growth as well as tax-free withdrawals for qualified higher education expenses. Qualified higher education expenses include tuition and fees, lodging and board, books, computers, and special education expenses.
What does this imply for you moving forward? Because the money in a 529 plan increases over time, the monthly payment may be significantly smaller if you choose to go that route. For a child who will be born in 2022, a good amount to put into a 529 plan each month would be about $140 for a public school inside the state, $215 for a public school outside the state, or $350 for a private school.
If you plan to save money using either a conventional savings account or a taxable investment account, you will need to change the amount of money that you put away each month so that it corresponds appropriately.
As an example, the average interest rate on savings accounts as of January 2022 is only 0.06 percent annual percentage yield (APY). At that rate, you would need to contribute approximately $230 per month to a savings account for a period of 18 years in order to pay for a third of the projected cost of a public in-state college; approximately $350 for an out-of-state college education; and approximately $550 per month for private higher education.
When compared to a 529 plan, it is far more than the minimum needed savings amount.
If you want to get much better returns on your investments, you might consider opening a taxable investing account. A monthly contribution of about $115 would cover the projected cost of attending a public university within the state, while $180 would cover the cost of attending a public university outside of the state, and $290 would cover the cost of attending a private college.
You will not, however, be eligible for the tax exemptions that the 529 plan provides for dividends and gains.
Make a decision based on what you are able to pay for
The last step is to determine a monthly savings target for college based on the amount that your family is able to put away. If there is not a lot of wiggle room in your budget, you should consider this strategy.
It goes without saying that the definition of what a family can afford will seem very different from one to the next. If you aren't sure what your family can do, try breaking it down using the Rule of 10 methods created by the Lumina Foundation.
Although it was conceived initially as a standard for educational institutions that were working to broaden students' access to higher education, the formula is clearly applicable to families. It is recommended to families that they pay for college using the following benchmarks:
- 10 percent of families' discretionary income is set aside for savings.
- Ten years' worth of savings is accumulated by families.
- While attending college, students are required to work ten hours a week.
Discretionary income is often described as total income after taxes, minus all essential living expenses such as food, medicine, housing, utilities, insurance, transportation, and so on. This leaves the individual with a net amount that can be spent however they choose.
The Lumina Foundation, on the other hand, says that a person's income must be at or above 200 percent of the federal poverty level for it to count as "discretionary" income for these benchmarks.
In the year 2022, this would equate to an income of $55,500.7 or more for a household of four.
Using this calculation, a family that brings in a yearly income of $100,000 might be able to put away ten percent of the remaining $44,500, which would be equivalent to $445 every month.
That adds up to more than $53,000 saved for college over the course of a decade. If a student works 10 hours per week for 50 weeks per year at the current minimum wage of $7.25, they will have earned an additional $3,625, bringing their total contribution to $14,500 over the course of four years.
Naturally, if there is a change in the amount that you bring in each month, either up or down, your contributions can be modified proportionately. And you can always make this strategy go further by using a tax-advantaged savings mechanism to grow your money over time. This will allow your money to grow much faster than it would otherwise.
For instance, if a family with a child who is 8 years old started saving $445 per month in a 529 savings plan, that amount would grow to be sufficient to cover the third of the cost that experts recommend for a public school that is located in another state or approximately half of the cost of a university that is located within the same state.
A Few Parting Thoughts
Although it's easy to get sticker shock from rising college costs, it's important to keep in mind that the amount of money you actually need to save is probably considerably less.
The most essential thing is to begin saving as soon as possible and to maintain a steady pace throughout the process. However, if your child is older, there is no need for you to freak out because you may still save a considerable sum in a much shorter amount of time.
Financial aid, scholarships, student jobs, your salary while your child is attending college and gifts from family members are all potential ways to help fill in the remaining gaps in funding for higher education.
What is the Most Effective Way to Put Money Away for College?
Because of the favorable tax treatment, many industry professionals believe that investing in a 529 plan is the most effective way to save money for college. As long as the dependent student or their parent holds the account, a 529 plan does not typically need to be reported on the FAFSA.
However, withdrawals may result in a reduction in the total amount of financial aid received by the student. Withdrawals from Roth IRAs are another option for funding a college education. However, withdrawals from a Roth IRA are considered income for the purpose of determining eligibility for financial aid. In addition, the only things that may be withdrawn at any time are contributions.
If the owner of the IRA is younger than 59 and a half years old, then any earnings would be subject to income tax as well as a penalty for early withdrawal.
How Does One Start a Section 529 Plan?
You will need to determine whether you want to open a prepaid tuition plan or a college savings plan before you can open a 529 plan. Prepaid tuition plans are more popular than college savings plans. Following this step, you will be prompted to select a service provider and decide on a plan to purchase.
When choosing a plan, make sure to take plan fees into consideration. You will also need to select a beneficiary for the account and add money to it. If you've settled on a plan for long-term savings, the next step is to determine how you want your money to be invested.
