Where do I start?
Each situation is different, but there are some general guidelines and concepts that need to be understood as your family prepares to send your children to college. Ideally, if you had saved for college regularly from the time your child was an infant, the impact of compounding would have placed you in strong financial position by the time your child graduated high school. Unfortunately, most families have not been fortunate enough to begin a college savings program while their little ones were still in diapers. Further, with the costs of higher education growing faster than the overall inflation rate, the parents of today’s toddlers might have to face college expenses of over $200,000.
The numbers are intimidating, but deliberate planning and learning about all the resources available to help fund your child’s college expenses will allow you to enter the college years with some assurance of success. Time is on your side, and thus you should begin setting aside funds for your child’s education as early as possible. If you find that you have not put away sufficient funds, there are still many resources available.
Here are some tips that financial advisors use to help parents prepare for financing their children’s college years.
- Don’t sacrifice saving towards your own retirement to pay for college. Although saving for both college and retirement should be part of the same financial plan, there should be trade-offs when balancing these goals. More resources are available to your children for funding a college education than those available to fund retirement. There are no grants, scholarships or guaranteed loans available to retirees.
- The earlier you start saving the better. The impact of compounding will help grow your college savings accounts over many years. For example, saving $100 per month towards college over 18 years will yield over $43,000 assuming a 7% annual interest rate.
- Because tuitions and other college expenses have risen faster than overall inflation (on average, tuition tends to increase by about 8% each year), college savings should be invested in a portfolio that grows faster than the rate of inflation on average over time. While your children are younger, their college accounts should be invested more heavily in equities (stocks and mutual funds) and as they approach the end of their high school years, their portfolio should be shifted more towards fixed assets (bonds, money market, and cash) to protect the account values.
- Discover other resources to fund college. Your children may qualify for government and private grants and loans. This will help pay a portion of the college expenses, and thus the family will not have to rely completely on savings and current income to pay tuitions costs. There are many scholarships available for eligible students. Not only are there academic and athletic scholarships, but also many scholarships based on a student’s unique interests, affiliations, or demographic background.
- College savings plans are a great way to systematically save for college and offers some unique advantages. A 529 Plan is an education savings plan offered by many states and some institutions designed to help families set aside funds for future college expenses. In most plans, the choice of school is limited by the state that sponsors the 529 Plan, however most states offer incentives with their 529 Plan if the student attends college within the state. Many 529 college savings plans which offer state tax breaks. Withdrawals from 529 plans to pay for higher expenses are generally free of federal tax and some state income taxes. Most 529 plans are transferable to other family members. Thus, if the child in which the 529 plan was started doesn’t require the plan to fund college, the assets may be transferred to the college costs of another family member.
- Take advantage of all the tax breaks available for qualified tuition and college expenses. Many families may be able to take advantage of two Federal income tax education credits: the American Opportunity Tax Credit or the Lifetime Learning Credit. Earnings grow tax-deferred on 529 Plans if the assets are used to pay for qualified education. Coverdell Savings accounts and U.S. Savings bonds also offer tax advantages when used to pay for qualified education expenses.
- If you do need to take out a student loan to pay for college expenses, understand the differences of the different types available, both subsidized and non-subsidized loans. Generally, qualifying for a student loan is simpler than other types of loans. Interest on a Federal, subsidized loan does not begin to accrue until after graduation; interest on private loans typically begins accruing while the student is attending school. The student may be able to deduct up to $2,500 of student loan interest charges each year.
- Begin planning your strategy to apply for Federal student aid during your student’s freshman year in high school. Several strategic decisions must be made several years before the student starts college. There are a variety of policies a college uses to award student aid, but most look back at several years of a family’s income to determine eligibility. By addressing these issues early, a family may be able to best shield some resources from consideration in the financial aid calculations.
For an individual recommendations and advice on you college savings plan, call a Member Services Advisor at AAFMAA at (800) 522-5221.
John Sledgianowski is an AAFMAA Benefits Advisor.