When Should You Start a College Savings Plan?

As you probably already know, college tuition has become more expensive than ever before! With tuition alone costing thousands of dollars, plus the cost of books, room, and board, it’s no wonder why student debt is a massive issue.

If you have a child or multiple children, chances are you’ve wondered if there is a strategic way to financially plan for their college education so they don’t have to start adulthood with a mountain of college debt. The answer is yes!

When it comes to a college savings plan, starting earlier is always the best strategy – you can begin to build a college fund account for each of your children. Keep reading to learn more about the best time to start a college savings account and the best tips for financing your child’s college education.

The Financial Benefits of Starting Early

The earlier you can start saving for your child’s college tuition, the better. There are several types of accounts that accumulate interest over time. This means that the earlier you start saving, the more time your money has to grow, with the interest compounding over time.

Here’s an example – let’s say you start saving for college as soon as your child is born. You invest in an account and save $30 a week for the first 8 years of their life but then stop—making the total investment equal to $12,480. If this account earns 6% a year, you’ll have about $28,500 by the time your child turns 18.

Now, imagine you wait 8 years before you start to save, and then save the same $30 per week until your child is 18. Factoring in the $12,480 investment and 6% return, you’ll have about $16,800 by the time they go off to college.

As you can see, you’ll earn nearly $11,700 more for college in the first scenario, even though you still saved for 8 years in each example. This is all because of the power of compounding – the more time your money can grow, the better!

Saving for College: The Order of Operations

Looking at the price of college and the recommended savings milestones might give you sticker shock, but it’s important to follow the correct order of operations when saving – think of the phrase Y.E.S.

• Y (You): You should always take care of your own financial health before saving for your child’s future. After all, if you can’t pay the rent, grocery bill, or utilities, your child’s basic needs won’t be taken care of. This bucket also includes ensuring you have an emergency fund while saving for retirement. You can’t get a loan for retirement, so make sure you save for yourself first!
• E (Education Savings Accounts): Once you can comfortably pay all the bills while still contributing to retirement and an emergency fund, you can start contributing for your child’s college savings fund.
• S (Savings): Any additional money you have left over at the end of the month after your bills are paid and you’ve contributed to your retirement and an education savings account can be put into savings, whether for your emergency fund or a large future purchase.

Recommended Savings Milestones by Age

At this point, you might be wondering how much you should be contributing to a college savings account – and the answer will depend on the state you live in, if your child will go to an in-state or out-of-state school, and the percentage of their college tuition you plan on helping them with (remember that you don’t have to pay 100% of their college!).

Fidelity has an excellent free calculator to help you determine how much you should save based on your situation. In most cases, they recommend saving between $37,328 and $245,427 total by the time your child turns 18.  Although this is a massive range, your needs will depend on your personal situation.

The lower end of this range is for someone who wants to help their child pay for a public four-year college, while the high end of this range is for someone who wants to help pay for a private four-year college.

Keep in mind that many students receive financial aid and scholarships, even at a private school. This means you may not even need to save towards the higher end of this savings range.

Here are some recommendations for college savings targets at each stage of your child’s life:

Birth to Age 5:

As we mentioned earlier, starting earlier is better so you can take advantage of compound interest in a 529 account. By the time your child turns five, you should have saved between $6,723 and $44,206. This means that, ideally, you should save between $1400 and $8,000 per year for the first five years of your child’s life. You’ll hit the lower range by saving just $120 per month during these years.

Age 6 to 10:

By the time your child reaches middle childhood, you’ve likely upleveled your career, and have a bit more wiggle room to contribute more to their 529 plan. Experts recommend you reach between $15,792 and $103,834 by the time your child reaches the age of 10. Continue to monitor the account to see how much you are earning in compound interest and contribute accordingly.

Age 11 to High School Graduation:

When your child reaches 18, you should have between $37,328 and $245,427 in your child’s 529 account. If you have remained consistent throughout your child’s entire life, reaching the lower end of this range shouldn’t be a problem, especially with compound interest!

Types of College Savings Accounts

When it comes to college savings accounts, you’ll have a few different options:

1. 529 Plan

This is the most common option for college savings, and this is because it offers more advantages. Here’s how it works: You’ll open a 529 plan, contribute to the account (post-tax), and your money will be invested over the course of several years. There isn’t a high-risk exposure, but you could earn modest returns on your contributions.

The best part? Any returns you earn in this account will be exempt from federal taxes, giving you a tax advantage. Plus, any returns used on education expenses, including tuition, books, fees, and other things, will also be withdrawn tax-free.

If your withdrawals are not used for educational purposes, the principal portion of the withdrawal is still tax-free, but the earnings on the disbursement will be taxed.

Every state offers some type of 529 plan, but each one has a different investment portfolio and is managed separately from each other. You are eligible to apply for any state’s 529 plan, no matter where you live! This means that if you live in Illinois, but find out that North Carolina has a better 529 plan, you are free to apply for it!

If your child decides not to go to college, you can transfer this account to one of your other children, a niece or nephew, or even yourself if you choose to go back to school!

2. Coverdell Education Savings Accounts (ESAs)

While 529s are solely meant for higher education expenses, ESAs can also be used for K-12 expenses. This investment account allows you to save up to $2,000 per year for your child’s education expenses – making it a great option if you want to send your child to private school during their grade school years.

Like a 529, contributions to an ESA grow tax-deferred, and withdrawals are tax-free if you use them for qualifying education expenses. This can give you more flexibility if your child does not end up attending college.

There are a few more rules for ESAs than other options. First, there is an income limit of $110,000 for individuals and $220,000 for married couples. The funds must be used by the age of 30 – unused funds after this age are subject to taxes and penalties unless transferred to an ESA in the name of another qualified family member. Keep in mind that there is no age requirement for a 529.

On the other hand, you do have more flexibility when investing in ESA funds – you can invest in stocks, bonds, mutual funds, and even alternative investments, giving you more control.

3. Custodial Accounts

Another way to save for college is with a custodial account – this is essentially a savings account that a parent controls for their child until they reach legal age. Here’s how it works: you contribute to your custodial account, and an account manager invests in it for you.

Then, when your child reaches the legal age, which is 18, 19, or 21, depending on the state where you live, the account automatically transfers from you to your child.

Unfortunately, custodial accounts do not have the same tax advantages as a 529. While the withdrawals from the custodial account don’t have any penalties as long as they are used for the benefit of the child, any returns in the custodial account are taxed. The good news is that this is taxed at the child’s tax rate since they technically are the owner of the account.

Custodial accounts do not have household income restrictions or annual contribution limits, but the beneficiary is not allowed to change. Although you can save for your child’s education this way, this isn’t always the best option. Because the money in the account is considered an asset of your child, it can reduce their financial aid eligibility. Be sure to speak with a financial advisor before opening this type of account!

Tips for Maximizing College Savings

1. Save every penny of your child’s holiday and birthday money: Chances are, your child receives a substantial amount of gift money each year from grandparents, aunts, and uncles. A little bit over time really adds up down the line. Use a service like Backer, which makes 529 gifting super easy.
2. Check out Upromise: This service will give you cash-back rewards for linking a credit or debit card and using that card at certain retailers. Just by doing your normal shopping, you can earn 1% to 25% back, and some users earn up to $1000 per year! You can even get a bonus for linking your 529 plan to your account.
3. Encourage your child to work hard in school and extracurricular activities: The better your child’s grades, the more scholarship money they are likely to receive. And if they are skilled in sports, music, foreign languages, or other activities, they can also get scholarships for these. That’s why they need to work hard in high school to reap these benefits.
4. Focus on earning more money: Instead of trying to cut down your budget, consider where you or your child could earn more. This could mean getting a higher-paying job, starting a side hustle, or your child working a part-time job when they reach the appropriate age.

The Best Time to Start is Now

Even if your child is already in middle or high school, the best time to start is always now! At this point, it may seem like it’s too late, but every bit you save will help your child in the long run. These dollars may not have much time to grow, but every dollar you can put away will be one less dollar your child has to borrow. Not to mention, choosing a college savings plan that has tax deductions or tax-free withdrawals is a win no matter what.

Conclusion

Saving for your child’s college education, especially if it’s in an account with tax benefits, is the gift that keeps on giving. Although saving for college may feel like a monumental task, you can make significant progress through consistent small savings over time. You’ll pay less in taxes while investing in your child’s financial future, giving you and your kids more peace of mind.

Start planning and exploring options for a child college savings fund with Think Life today – we’re here to help you take control of your family’s financial future!