College is getting more expensive each year. Will your kids be able to afford the cost? In this month’s installment of the Peace of Mind Challenge, get a step-by-step guide to help you set up a college savings plan for your kids.Guys, I’m LOVING this Peace of Mind challenge! After January’s challenge, I’ve got my fireproof safe all in order with my passport and other documents locked safely inside. Wahoo! Side note: fireproof safes are a lot heavier than I expected. Holy cow!
Anyway, it feels so good to have one thing checked off my list. Did you do the January challenge? If so, how did it go?
Now onto February’s challenge:
How to to set up a college savings plan
Did you know that Americans owe over $1.48 trillion in student loan debt? The average college student in the class of 2016 graduated with over $37,000 in student loans. That’s CRAZY! I can’t imagine coming out of college owing that much money. My entire year’s salary as a first year teacher wasn’t even that much–how would I ever have paid it off?
I don’t want my kids to be paying off student loans until their own kids are in college, so I’ve felt strongly about setting up college savings plans for our kids. My husband and I have been talking about it since our first child was born almost 6 years ago. But–like so many other tasks–it got pushed to the back burner and hasn’t happened.
No more! I’ve spent the last few weeks researching the ins and outs of college savings plans, and I’ve learned a TON. After hours of reading up on policies and comparing college fund options, I’ve decided on a fund and set up each of my kids as beneficiary of their own account.
Now I’m excited to share all my new-found knowledge with YOU. Hopefully, this article will save you some time sifting through the sea of information out there. Because we all know that anytime money and the government are involved in something, it can get a little… complicated.
First things first…let’s answer the big question…
Should I create a college savings account for my kids?
Saving for your kids’ college educations is a great idea. However, before you invest in their futures, make sure you have your own financial ducks in a row. Many financial advisors recommend the following before investing in a college savings plan:
- pay off all personal debt (credit cards, your own student loans, etc.).
- have a rainy day fund in place that can cover 3-6 months of your families expenses in case of lob loss or other emergency.
- be contributing 15% of your income to your own retirement fund.
If you have already done those things, wahoo! Let’s get saving for college!
(Side note: If you want a great strategy for getting out of debt, I love the “snowball” model.)
Why start a college savings plan? – THE BENEFITS
Why should you invest in a college savings plan rather than just sock the money away in your own savings account? Well, here are the main benefits:
- You are investing the money rather than letting it grow in a low interest account, so your potential earnings are greater. (Note: You could also lose money since investments aren’t guaranteed, but over time you’re likely to come out ahead).
- Money grows tax free, and as long as you use the funds for educations purposes, you’ll never have to pay taxes on your earnings within the fund.
- Many states offer tax incentives for contributing to a college savings plan. Find out more about your state’s policies here.
- Studies indicate that kids who have college funds are more likely to attend college than their peers who don’t have a savings plan in place.
- Saving the money up front means you and your child will go into less debt for college, and consequently avoid costly interest on student loans later.
What are the limitations of savings plans?
I’ve told you the good, but what about the other side of the coin? Here are a few limitations to be aware of when considering a college savings plan:
- All funds must be used for education expenses. If you pull the money out for non-approved expenditures, you will have to pay tax on the earnings AND pay a 10% penalty. Ouch. However, if your child doesn’t use some of the money in his/her fund, you can transfer the money to another family member’s account. This article gives some great ideas for what to do if you have leftover money in your 529 plan.
- It is an investment, so you could actually lose money if the market tanks. There are some low or no risk plans that are FDIC insured, but the possible growth is less than standard investment accounts. Choose how much risk you want to take.
Types of college savings plans:
You’ve got two main options for college savings funds:
OPTION #1: Coverdell Educational Savings Account (also known as the “Education IRA”)
OPTION #2: 529 college savings plan
**Note: There are two kinds of 529 plans: investment accounts and prepaid tuition accounts. In this article I’ll focus on investment accounts because they are more common (and considered by most people to be more desirable).
Both plans follow the same basic model: you save/invest money now, and it grows tax-free until the beneficiary of the plan withdraws the funds to pay for qualified educational costs.
There are other ways to save for college, but ESAs and 529s are the most common. There is A LOT of information out there regarding these plans–and you could get lost for hours in the depths of the internet researching them–but here are the key facts:*Important Note: A lot of (outdated) articles claim that one of the big differences between ESA funds and 529 plans is that ESA funds can be used for K-12 tuition, but 529 plans are limited to higher education costs. This used to be true, but the most recent changes to tax law now allow payment of K-12 tuition from 529 plans. If you plan to send your kids to private school, this is an impactful change. If not, it frankly doesn’t matter.
What can these funds be used for?
- Tuition and fees for any accredited school whether college or university, or private K-12 school.
- Room and board
- Books, required supplies
- Educational technology (computers, educational software, internet service, etc.)
*Note: you can’t use it for technology that is primarily for personal/entertainment purposes.
How much should I save for my child’s college education?
College tuition varies widely, depending on where you go to school. According to The College Board, the average cost of tuition and fees for the 2017–2018 school year was $34,740 at private colleges, $9,970 for state residents at public colleges, and $25,620 for out-of-state residents attending public universities (source).
Fidelity Investments recommends the “2K rule.” Basically, multiply your child’s age by 2,000 to get the amount of money you should currently have in a savings plan.
Ideally, by the time your child is 18 and heading off to college, you should have $36,000–plus earnings–to set them up for college. This likely won’t cover all costs, but when combined with financial aid and scholarships, it will minimize the need for student loans.
My oldest son is 5, so I would ideally have $10,000 currently. It may take some time to work up to this since we’re starting late–oops. Better late than never though.
You can use Fidelity’s college savings calculator to get a more specific recommendation of savings for your individual situation.
Just remember that it’s better to save SOMETHING than nothing. Don’t wait to start your savings plan just because you can’t commit right now to saving as much as some impersonal, online calculator tells you. Just sayin’.
Ready to set up your savings plan?
Follow the steps below and you’ll have the account of your choice set up in no time.
Be sure to download the FREE PRINTABLE WORKBOOK to walk you through the process.
Step 1: Choose a plan.
Which plan should I choose?
You can make the process of choosing a college savings plan as easy or complex as you choose. There are over 100 options out there. Agh! Serious information overload.
After hours of research and talking it through with my husband, we decided to open a 529 plan. Our state (Utah) has a highly rated plan with good tax benefits, so we chose to stick with our own state. You can invest in a plan in another state, but you may or may not be able to reap the income tax deductions/credits if you opt for another state’s plan.
Why did we opt for the 529 over the ESA? The main draw of ESA plans is the ability to self-direct investments rather than being locked into the limited options the plan offers. However, we were content with the investment options offered by our state’s 529 plan, so we didn’t feel a need to micromanage. More importantly, if we had opted for an ESA, we wouldn’t get the tax credit offered by the Utah 529 plan. Also, we would have been limited to contributing $2000 per year. I don’t know if we’ll hit that limit, but I like to have the freedom to save as much as we want.
Here’s my recommendation:
Start with your own state’s 529 plan, and use a site like collegesavings.org or savingforcollege.com to compare costs as well as benefits/drawbacks of various plans. If your state is relatively well-reviewed and has low fees, go with it.
If you REALLY want to do more research to see if another state’s plan is better, knock yourself out. Just try not to fall down the rabbit hole of options while trying to make your choice.
If you choose to open an ESA, you can do so at almost any brokerage firm or bank.
Questions to ask yourself about the plan you’re considering:
- How much money do I want to contribute yearly?
- ESAs only allow up to $2,000 per year per beneficiary.
- How many years do I have left to contribute before my child will need the funds?
- If you have an older child who will need fund sooner, you may want to consider a 529 which will allow higher contributions.
- Consider age of the beneficiary when deciding how aggressive you want to be in investing. Many 529 plans offer age-based investment options that start out more aggressive and get more conservative the closer it gets to the time your child will need the funds.
- What are the tax incentives in my state?
Answers to the following questions should be available on the website for each plan:
- How well rated is my state’s 529 plan?
- How has the plan performed for the past 3 years?
- What are the investment options?
- What are the fees?
- Tip: Buy directly from the state plan instead of through a management group to limit fees and management costs.
Step 2: Read the program description
Before investing in any savings plan or investment fund, make sure you read the program description so that you know all the fine print regarding requirements, fees, investment options, etc. This is your best resource to answer any remaining questions you have.
The plan’s website should make the program description easy to find. The Utah one has links to their program description in big, bold letters in several places advising people to read it.
Step 3: Gather needed information
In order to actually set up the plan, you’ll need some basic information about both the account owner (likely you) and the beneficiary (your child). Here’s what you’ll need:
- Social Security Number
- birth date
- (optional) your bank routing and bank account numbers for automated electronic contributions
Step 4: Choose your investments
Which kind of investments you choose will depend on several factors:
- What are the investment options offered by your plan?
- How many years will your money have to grow before it will be needed?
- How much time/effort do you want to spend managing the investments?
- How much risk are you willing to take?
Financial professionals generally agree that higher risk investments have the potential for higher rates of return. Learn more about the “Risk and Return Spectrum” HERE.
Step 5: Actually open a savings plan
You have everything you need. Now, go do it! Once we decided what plan we wanted, it only took about 15 minutes on the plan’s website to actually set everything up. It was super easy and efficient.
That’s it for February’s challenge, friends. Good luck getting your college funds set up this month! Let me know how it goes, and if you have any questions along the way (I can’t guarantee I have the answers since I’m just learning all this, too, but I have done A LOT of reading on the topic lately).
And now, a little poll:
What do you want to dive into for March’s challenge? Emergency grab-and-go kits for the family or how to write a basic will?
Let me know in the comments!