Over the last two decades, the cost of a college education has nearly tripled. Many high school graduates that want to further their studies require a student loan to pay for tuition, books, and housing. Without government-sponsored loans, there would be fewer kids in college.
However, student loans are a double-edged sword. While they help kids get into college, they also shackle them with vast amounts of debt. As a result of the loans, most college students graduate with an average of $36,000 in debt. Some students may have loans for three or four times that amount.
Starting your working career on the back foot can and delay a college graduates transition to adulthood. Trying to buy a home or start a family when you have thousands of dollars in loans is challenging. The financial uncertainty of the situation is causing Americans to delay marriage and starting a family.
Statistics show that it takes the average student around 21-years to pay off their student debt. This situation means that the average student is near 40-years old by the time they finish paying off their loan account.
As a concerned parent, you probably don’t want your kid to have to deal with a mountain of debt after their college graduation.
By starting a savings account or investment for their college career, you give them a head start in their adult life. Here are a few excellent ways to build savings for your child’s college education.
Take Advantage of 529 College Accounts
- 1 Take Advantage of 529 College Accounts
- 2 Use a Coverdell Savings Account
- 3 Open an Account with a Mutual Fund
- 4 Open a Roth IRA
- 5 Investigate Prepaid Tuition Plans
- 6 Form a Trust
- 7 Invest in Index Funds and ETFs
- 8 Speak to a Financial Advisor
- 9 The Final Thought – Start Saving Early
529 College Savings Plans also operate similarly to an IRA. These vehicles allow parents to invest their after-tax dollars into a low-cost, diversified fund. The parents can withdraw the money tax-free, and use it to pay for their kids’ college education.
Some 529 funds operate similarly to a 401(k) plan. During the child’s formative years, the fund invests into riskier assets that are more challenging to liquidate. However, these assets often yield the highest returns. As the child reaches college age, the fund manager switches the investments from high-risk to low-risk.
Low-risk portfolios may earn less in percentage profits, but they are far more secure. There is also less risk of losing money if there’s a market shock. 529 Plans also offer the parents some significant tax advantages as well. A 529 plan provides tax-deferred gains if the parents use the money to pay for their child’s education.
Some states changed the law with how 529 Plans operate. As a result, if your child does not want to go to college, you can withdraw the savings. However, you might also have to settle penalty fees for early withdrawal.
CollegeBacker – Simple Way to Start a 529 Plan
CollegeBacker allows you to benefit from a 529 Plan at the click of a button, meaning that your savings will be shielded from tax.
Moreover, not only does CollegeBacker give you the option of choosing a 529 Plan that adjusts the underlying risks of its investments as your child gets older, but the platform also makes it a seamless process for friends and family members to add money to the pot as and when they see fit.
Read our complete CollegeBacker review here to find out more.
Use a Coverdell Savings Account
Coverdell savings accounts are a viable alternative to using a 529 Plan. Both Coverdell and 529 plans allow parents to make payments into the facility using after-tax dollars. As a result, any growth in your savings is tax-free. The IRS won’t charge you any capital gains tax on your final withdrawal, provided that you use it to fund education costs.
Coverdell ESAs offer more room in defining the terms of a qualified expense for a withdrawal. While the fund covers the costs of tuition, but it also allows you to withdraw for other education expenses as well. Coverdell ESA can cover tutoring programs, uniforms, and any additional K-12 costs, without the call for a penalty on your withdrawal.
The most significant disadvantage of a Coverdell ESA is the limited contribution. The government only allows parents to contribute $2,000 to the fund per beneficiary per annum. It’s also important to know that kids over the age of 18 do not qualify for a Coverdell ESA, and the parents must withdraw the funds before the child turns 30-years old.
Open an Account with a Mutual Fund
When you start saving for your ‘child’s education, ‘it’s tempting to open a savings account attached to your online banking profile. However, we ‘don’t recommend you take this approach. A savings account offers very little in returns, and you ‘won’t benefit from the effect of compound interest.
Compound interest means that you earn money on the interest and the capital amount in your account. As a result, the saver experiences exponential growth in their money after 10 to 15-years of making contributions.
The best way to take advantage of compound interest is with investing in a mutual fund. Mutual funds are investment vehicles managed by financial firms. These accounts pool ‘investors’ money to increase the buying power of the fund. A money manager invests the funds in the account into a portfolio of bonds and stocks in an attempt to make “Alpha,” or realized profits.
You pay a management fee on your account that covers the fund’s expenses throughout the year. Most mutual funds pay you anything from 8 to 12-percent a year, depending on your risk tolerance and market conditions.
There is no limit on the amount you can invest in the fund, but all your profits are subject to a capital gains tax. Therefore, it’s best to work out the taxable amount before you make any withdrawal from your account.
Open a Roth IRA
The Individual Retirement Account is a popular method for saving for retirement in the United States. There are two types of IRAs. The first is a traditional IRA, and the second option is a Roth IRA. The difference between the two IRAs comes in the tax obligations to the investor.
With a traditional IRA, you pay taxes on your final withdrawal amount. The IRS charges you depending on your tax bracket at the end of your career. With a Roth IRA, you pay tax on your contributions, but your final withdrawal is tax-free.
Therefore, a Roth IRA is a suitable investment vehicle for saving for your kids’ college fund as well. Under normal conditions, the financial services firm won’t let you drawdown on your money in your IRA account until you are 59.5-years old.
However, there are certain exceptions to this rule. One of the stipulations in the contract states that you can withdraw funds from an IRA to pay for education expenses, such as a college degree.
An IRA works similarly to a mutual fund. The firm pools investors’ money, and they use it to purchase assets for the fund. However, with an IRA, you have exposure to a broader range of financial assets in your portfolio. The fund manager may choose to include assets like property portfolios, index funds, and debt vehicles in emerging markets.
More on IRAs:
- What is an IRA? Complete Guide to Individual Retirement Accounts
- Your First Individual Retirement Account (IRA): What You Need to Consider
- What’s the Difference Between a 401k & an IRA? Complete Guide
Investigate Prepaid Tuition Plans
A prepaid tuition plan offers parents with an alternative to a 529 Plan. This vehicle provides a savings account for parents that are certain their child will attend an in-state public college. The prepaid tuition plan allows parents to save for credits against tuition fees at a preordained price.
Prepaid tuition plans retain the same tax advantages and parental protection as 529 Plans. However, they don’t have as much exposure to the stock market, reducing the fund’s exposure to market volatility.
If your child decides to attend university out of state, then they might not get the full value of the funds or credits in the plan. As an example, if you bought a year of tuition at a Florida state school for $14,000 and now the costs of education are $20,000, your child gets a full year of college.
However, if they decide to go to school in New York, they get a return on the investment of around $16,000, but they would not get the full $20,00 for a year of school. Similar to 529 Plans, prepaid college tuition plans allow the parents to change the beneficiary. However, you’ll have to pay a penalty fee and capital gains tax if you use the money for anything other than education expenses.
Form a Trust
Opening an educational trust is an option for parents that want to send their kids to college. When a person wants to keep control of another person’s assets, they form a trust. With a trust, you eventually plan on handing over the assets or funds to the beneficiary of the trust. With a trust, you can arrange with your lawyer to only release funds for educational expenses.
By controlling the trust, you limit your child’s access to the funds, preventing them from acting irresponsibly with the money. Therefore, your child cannot dip into the trust to buy a new car or use it to go on vacation.
A trust is an agreement between the trustees (the parents), and the beneficiary, (the children). Trusts also have a level of flexibility that makes them ideal for managing any other education expenses. If you open a family trust, the vehicle remains open, even after your passing. This feature of trusts makes them viable for anyone that’s looking to preserve their wealth and pay less in estate duties after they pass.
While trusts are a suitable vehicle for controlling assets, it will not earn you any interest on your money. However, you can transfer your assets, such as your mutual fund, into the trust, safeguarding it from misuse.
Invest in Index Funds and ETFs
Index funds and ETFs are self-managed investments that you can access through a full-service or discount broker. Exchange-Traded Funds are funds set up to track the price action of various assets and commodities. For example, there is an ETF that tracks the price of gold.
These funds give you direct exposure to movements in the markets, and you can invest as you please. However, we don’t recommend you to manage these kinds of investments yourself if you don’t know what you are doing.
Learning to trade indexes and ETFs takes some experience, so you might have to attend an investment course to learn how to do it by yourself. However, if you do learn to trade these assets, then you could profit from movements in the markets. Gold, oil, and other commodities are popular ETFs with plenty of volume and interest from the investing public.
It’s important to note that using ETFs and index funds can be hazardous for your finances. If the market experiences a sudden crash, you could lose a significant portion of your funds. The returns are higher if you decide to self-manage your account, but a professional money manager will always do better than your best efforts.
More on ETFs & Index Funds:
- What is an ETF? The Complete Beginner’s Guide to ETFs
- What are Index Funds? And Which Should You Invest in?
- The Best S&P 500 Index Funds: Complete Guide
Speak to a Financial Advisor
When you start a fund for your child’s college education, speak to a financial advisor. An advisor can help you adjust your budget to meet your monthly savings goals. They sit with you and examine the costs of college education, and what you can expect to pay by the time your kid goes to college.
Advisors can help you adjust your savings rate to beat inflation. They give you a clear indication of the dollar figure you need to save every month to meet your goal. Advisors are experts in finding areas when you need to cut back your expenses. By saving money on your monthly bills, you have more money to put toward your kids’ college fund.
Advisors can also recommend the top-performing mutual funds and other asset classes where you can grow your money.
More on Financial Advisors:
- Guide to Financial Advisors: Everything You Need to Know
- When Is It Time to Hire a Financial Advisor?
The Final Thought – Start Saving Early
The earlier you start your child’s college fund, the better. It’s best if you start saving as soon as you find out you’re pregnant. However, many people don’t start saving for their kids’ college until they reach high school. As a result, many kids end up having to resort to student loans to make up the difference.
If you do start saving early, you don’t have to make massive monthly contributions. Start the investment with $50 or $100, and slowly increase your contributions over time. If you follow this strategy, there will be enough money for your kids to go to college and attend graduate school.
However, even if you start saving late, it’s better later than never. Give your child a financial advantage in life and help them out with their college fund. By keeping them out of debt in early adulthood, you give them more opportunity.