Getting a Head Start on College Savings

May 05, 2021

The U.S. Department of Agriculture estimates the cost of raising a child to the age of 17 for a middle-income family will be about $285,000.1
 That’s roughly equivalent to the median value of a new home in the U.S.2

And if you’ve already traded that supercharged convertible dream for a minivan, you can expect your little one’s college education to cost nearly $527,000.3

But before you throw your hands up in the air and send junior out looking for a job, you might consider a few strategies to help you prepare for the cost of higher education.

First, take advantage of time. The time value of money is the concept that the money in your pocket today is worth more than the same amount will be worth tomorrow because it has more earning potential. If you put $100 a month toward your child’s college education, after 17 years’ time, you would have saved $20,400. But that same $100 a month would be worth over $32,000 if it had generated a hypothetical 5-percent annual rate of return.4 The bottom line is: the earlier you start, the more time you give your money the potential to grow.

Second, don’t panic. Every parent knows the feeling – one minute you’re holding a little miracle in your arms, the next you’re trying to figure out how to pay for braces, piano lessons, and summer camp. You may feel like saving for college is a pipe dream. But remember, many people get some sort of help in the form of financial aid and scholarships. Although it’s difficult to forecast how much help your student may get in aid and scholarships, these tools can provide a valuable supplement to what you have already saved.

Finally, weigh your choices. There are a number of federally and state-sponsored, tax-advantaged college savings programs available. Some offer prepaid tuition plans, and others offer tax-deferred savings.5 Many such plans are state sponsored, so the details will vary from one state to the next. A number of private colleges and universities now also offer prepaid tuition plans for their institutions. It pays to do your homework to find the vehicle that may work best for you.

As a parent, you teach your children to dream big and believe in their ability to overcome any obstacle. By investing wisely, you can help tackle the financial obstacles of funding their higher education – and smooth the way for them to pursue their dreams.

When you’re ready to start thinking about saving for your kids’ college funds, it’s time to learn about the different types of education-based savings accounts. Here are three of the most common options:

529 Plan

A 529 Plan allows you to save money for any level of education (including graduate school) and apprenticeships. The contributions made to this type of account are not subject to taxes as long as the funds only pay for the beneficiary’s education expenses.

A 529 Plan has some stipulations.

  1. The funds have to be used for their intended purpose, otherwise, those funds are subject to taxes AND a 10% penalty fee.

  2. While there aren’t yearly contribution caps, there is a lifetime contribution cap of $500,000.

Roth IRA

When you think of a Roth IRA, you may assume it's strictly for retirement, but that isn’t true. A Roth IRA can help pay for an education, but like a 529 Plan, there are a few stipulations.

  1. The IRA has to be in the student’s name. No parent or grandparent can use their savings account to pay for the student’s education.

  2. The money can only be used for college. The funds can't pay for high school or trade school.

The contribution limit made to a Roth IRA is $6,000 per year. These contributions and earnings grow tax-free and the withdrawals from the account are also tax-free.

A great thing about using a Roth IRA as part of an educational fund is that if there are leftover funds, the beneficiary can use them in retirement.

Coverdell Education Savings Account

Coverdell Education Savings Accounts are created to help families fund educational expenses. Anyone can create this type of account as long as you’re over 18, and have the beneficiary’s full name, date of birth, Social Security number and address.

Just like with the previous options, there are some stipulations for using this type of account.

  1. There are only some schools that allow Coverdell Savings Accounts.

  2. Contributions have to be cash or a cash equivalent.

  3. The beneficiary can only use the funds until they're 30.

The maximum contributions are $2,000 per year.

A Coverdell could be a viable option for families who fall below a designated income level and may not have other ways to pay for further education.

Every beneficiary can have more than one education-based savings account, so take time to decide which combination of these options can work for you.

When you’re ready to start saving for your children's education, contact the office so we can discuss.

Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing.

Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state's 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investing in any state's 529 Plan.

A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

1. U.S. Department of Agriculture, 2020 (Most-recent data available)
2. The Washington Post, 2020
3. Wealth Management Systems, Inc., 2021 (Based on average tuition and fees for a 4-year degree at a private university, starting in 2039, and assuming a 5% annual increase)
4. The rate of return on investments will vary over time, particularly for longer-term investments. Investments that offer the potential for higher returns also carry a higher degree of risk. Actual results will fluctuate. Past performance does not guarantee future results.
5. The tax implications of education savings programs can vary significantly from state to state, and some plans may provide advantages and benefits exclusively for their residents. Please consult legal or tax professionals for specific information regarding your individual situation. Withdrawals from tax-advantaged education savings programs that are not used for education are subject to ordinary income taxes and may be subject to penalties.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2021 FMG Suite.