Having kids is the most incredible gift I’ve been blessed with. I have two little girls and another child on the way, and the amount of joy they bring to our lives is simply indescribable. One thing they don’t tell you enough (or maybe I just wasn’t listening) is how darn expensive those adorable things are.
We’ve discussed the cost of raising a child in past blogs, but updated studies are showing the average cost to raise a child in suburban America is right around $245,000. The crazy thing? That’s only until age 17. Then you still have college to pay for.
That brings us to our discussion about one of the largest financial expenses parents will ever face: college for their kids.
The bad news is that, yes, college is a massive expense. The good news? You have options. And the earlier you start to think about it, the more options you will have.
Let’s take a look at a few options:
Option #1 - Let your kids figure it out
It might sound funny (or brutal) but honestly the first option we are listing is to simply let your child figure it out on their own. After all, it is their future.
Benefits: The benefit of this option is it saves you lots of money. It also can teach your child discipline. Maybe they get a part time job to help them pay their way through college. That hard work might cause them to take school more seriously. If they are spending their own hard earned dollars rather than mom and dad’s, you better believe they’ll be paying better attention in class.
Drawbacks: It could discourage your child from going to college at all. That might be too insurmountable for a kid who might not fully understand the cost / benefit of such a decision. It might be more attractive to find a steady income somewhere and never attend college.
If they do decide to go to college and pay for it on their own, it could lead to mounds of student loan debt which could set them back for years after graduation.
Option #2 - Start saving now in a tax-favorable way
If you start saving now, you can do so in a way that could be beneficial to your tax situation. This is why we said thinking about college savings when your kids are little provides you with more options than if you think about it later on down the road. Here are a few accounts that you might consider:
- 529 College-Savings Account: an education savings plan operated by a state or educational institution that allows parents to put away money for college. This plan makes the most sense for the majority of parents. Each state determines the cap on the lifetime contribution; however, most states range from $100,000 to $270,000. Many states also offer tax deductions or tax credits for contributions. Withdrawals from the account are not subject to federal tax and your investment will grow tax-deferred.
In addition to the tax benefits, the account has minimum impact on the amount of financial aid a student could be eligible to receive since the account is generally reported as a parental asset on the federal financial aid application. As stated above, the plan is specific to each state but many states offer two types of savings plans. One plan the parents can sign up online and manage themselves. The second plan is sold through registered investment advisers or broker-dealers who help parents choose and manage their investments. These are referred to as direct-sold plans and generally have lower fees.
- Prepaid plans: a plan that allows parents to pay now for their child’s college education. You basically purchase the education at the current cost to avoid high tuition inflation. This can be a stand-alone plan or alongside a 529 college-savings plan. A potential downside is that you may not get the same benefit if your child attends a school that is not covered by the plan.
Most prepaid plans are open only to in-state residents. This plan is different from 529 college-savings plan in that parents do not pick the investment options. Instead, parents generally purchase semesters or units equal to the average cost at in-state public colleges and the plan will later cover tuition and certain fees.
- Coverdell Education Savings Account: a trust or custodial account created to pay for educational expenses of the designated beneficiary. It is more flexible than a 529 plan in that it can be used to pay for educational expenses from kindergarten through graduate school. Parents can open both a 529 and a Coverdell for the same child.
With Coverdell Education Savings Accounts, parents are able to choose the investments which include stocks, bonds or mutual funds. No contributions are allowed after the beneficiary reaches age 18 and the funds have to be used before they reach age 30. A beneficiary must pay a 6% excise tax on contributions above $2,000 a year.
Option #3 - Incentive-Based approach
Some parents might choose to pay for their kids’ education but are concerned that without the child having any skin in the game, they might not take college seriously.
If this is you, consider an approach where you incentivize your child to reach certain goals in order to receive the money you’ve set aside for education expenses. Get creative with it. This can help your child understand the self-discipline it will take to reach success and perhaps even the cost of failure. All invaluable lessons to learn as they begin to stand on their own two feet.
With this approach, you’ll want to start saving early, but perhaps not in an account where the expenses must be used for education. Consider a standard investment account, and contribute to it monthly. The average cost of college for a 4 year state school is $87,800. It will be more than that 20 years from now. Here’s a calculator that can help you when knowing how much to save.
As you consider the cost of college for your future children, there’s no right answer in what you should do to prepare. There’s only a right-for-you answer. That can be discovered by weighing your options, discussing with your life partner, and coming up with a set of financial goals which will most closely align with your life goals.
It all comes back to this: money is simply a tool which is exchanged for goods and services. With a bit of intentionality and smart planning, we can be sure that what get the most out of each dollar we earn, so we can spend it on the things that help us to get what we hope to get out of life.
Let us know if you would like us to help you put together a plan.