When you have a kid, your life changes forever.
My son was born in October, and just a few months in, I’m discovering all the incredible joys and challenges of being a mom. It’s amazing how such a little thing can take up so much space in my heart…and in our budget!
The cost of raising children in this country is high. According to a 2022 study, parents can expect to spend $310,605 (adjusted for future inflation) raising a child born in 2015 through age 17. And often, the expenses don’t stop when your kid turns 18. In fact, that’s when one of the most intimidating expenses pops up: college.
The average cost of attendance for a student living on campus at a public 4-year in-state institution is $26,027 per year or $104,108 over 4 years. And by the time your kid packs up their college ruled notebooks and iPhone 26, it’ll be even more expensive.
I know it’s scary, but take a deep breath.
Today, I’m going to help you figure out how to save for your kids’ college expenses, so that when they’re ready to fly the coop and pursue their higher education, you can help set them up for future career success without jeopardizing your financial position.
How to save for your kids’ college
1) Start early
Starting as early as possible will go a long way in setting you up for success.
The earlier you start saving, the more time your money will have to grow. Even small contributions made regularly can add up significantly over time thanks to compound interest.
That said, if you’re on a tight deadline – maybe your kid is already in high school – don’t panic! You still have options, you just need to save more aggressively and might need to look for alternative ways to save. I’ll dive into that in a minute.
2) Open a tax-advantaged account
Opening a tax-advantaged account will go a long way in multiplying your money safely and as quickly as possible.
When you’re saving for college, you have a few different options for tax-advantaged accounts:
529 Account
A 529 account is a popular choice for parents saving for their kid’s college education.
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education expenses. These plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. There are two main types of 529 plans:
College Savings Plans
These plans allow individuals to contribute to an account established for a specific beneficiary (typically a child or grandchild). The funds in the account can be used to pay for qualified education expenses at eligible educational institutions, such as colleges, universities, vocational schools, or other post-secondary institutions. Qualified expenses include things like tuition, fees, books, supplies, and certain room and board costs.
Prepaid Tuition Plans
These plans allow participants to purchase tuition credits or certificates at current prices for use in the future. The credits can typically be used at eligible institutions within the state's higher education system, although some plans may allow for use at private or out-of-state institutions.
Key features of 529 plans include:
- Tax Benefits: Contributions to a 529 plan grow tax-deferred, meaning you don't pay taxes on the investment gains as long as the funds are used for qualified education expenses. Additionally, some states offer tax deductions or credits for contributions to their 529 plans.
- Flexibility: Funds in a 529 plan can generally be used at any eligible educational institution in the United States and sometimes abroad. Additionally, the beneficiary of the plan can be changed to another eligible family member without incurring taxes or penalties.
- High Contribution Limits: While contribution limits vary by plan and are typically quite high, they are subject to gift tax limitations. However, individuals can make a lump-sum contribution of up to five times the annual gift tax exclusion amount without triggering gift taxes, provided they elect to spread the contribution over five years for gift tax purposes.
Overall, 529 plans offer a valuable way for families to save and invest for future education expenses in a tax-advantaged manner.
But the downside is if you don’t need the money for your child’s education, then you’ll have to pay taxes and penalties on the withdrawals. Also, your investment options are limited.
Roth IRA
Alternatively, you could opt to keep your child’s college fund in a Roth IRA.
A Roth IRA is a retirement savings account that allows individuals to contribute after-tax income, with the potential for tax-free growth and withdrawals in retirement.
There are some advantages to investing your child’s college fund in a Roth IRA:
- More investment options
- It can be used on expenses other than education. So, if your kid doesn’t end up going to college, then you’ve given them a head start on retirement savings.
Contributions can be withdrawn at any time without penalties, but earnings can only be withdrawn tax-free after age 59½ if the account has been open for at least five years. That said, you can remove money from a Roth or traditional IRA for certain qualified expenses – like higher education – without taxes or penalties.
3) Save consistently
If your kid is still young, then even small amounts can add up substantially by the time they reach 18.
For instance, let’s say that when your kid is born, you invest $5,000 in target date funds and contribute $100 every month until they turn 22. By the time your kid is 22, you would have saved and invested $31,400 and assuming an 8% annual return, your investments could have a value of more than $100,000 - which would be enough to pay for most of your kid’s college education!
4) Use windfalls wisely
If you get some unexpected money – like a tax refund or an inheritance – and your own finances are in order, consider adding at least a portion of it to your child’s college fund to help your money grow.
5) Ask your child to help
As parents, our natural instinct is to help and protect our kids. But that doesn’t mean that the responsibility of paying for your child’s college education sits entirely on your shoulders.
Sit down and have a heartfelt conversation with your kid about what they want, what you can afford, and how to make sure your child graduates with the brightest possible financial future. (Assuming they’re in high school already; if they’re still playing with blocks, maybe give it a few years.)
Depending on your kid’s aptitude and preferences, here are some ways they might be able to help cut down on college costs….
- Taking AP or community college classes in high school for college credit
- Applying for scholarships, grants, and/or financial aid
- Living at home
- Getting a part-time job (or taking a gap year to work and save)
- Attending community college for the first two years
- Choosing a cheaper school, like a public, in-state university, possibly close to home
Whatever you do, don’t make the mistake a lot of parents make by compromising your retirement savings for your kid’s college! Remember, if they have to, they can always get student loans, but there aren’t loans for your retirement. You owe it to yourself (and your kids) to look out for your own financial future.
Final Thoughts
College can be an intimidating expense, but I hope this gave you a few tips to make it feel less daunting.
If you want to learn how to improve your finances so you can build a better financial future for yourself and your loved ones, be sure to check out our free masterclass! In it, we’ll give you the secrets you need to know to master your money once and for all.
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