Once you become a parent, you realize how the rest of your life will involve in-depth financial planning for every big step in your and your child’s life. Saving for college seems like a great option but most parents are clueless where to start. Before you start putting away cash for your young one’s future, it is necessary to ask yourself the following questions:
1. How much do I need to save?
While estimates put the number at a relatively low sum for a public school, this number increases much more if the college is out of state, and to almost double the cost of a public school if it is a private university. If you take into account inflation, these numbers are likely to increase. However, scholarships, student jobs, family contributions, all make saving for college much easier.
2. What is my financial situation?
The amount that goes into saving for college funds depends on your current financial situation. If there is not much wiggle room in your budget, make monthly deposits that you can afford. Usually, it is convenient to save about 10% of your discretionary income towards your child’s college fund. Discretionary income is the sum that remains after you deduct taxes and the necessary expenses such as groceries, transportation, insurance, healthcare, etc. If you save this 10% for over 10 years, then despite small monthly contributions, you will have enough saved up at the end.
3. Should I pay for my retirement first?
One of the many dilemmas that parents face while saving for college is whether or not to cut back on their retirement fund. It is always better to have a safety net for yourself first. In the worst-case scenario, you can always rely on student loans to pay for college, but you cannot take out a loan to help with your retirement. Also, some parents are hesitant to invest in a retirement fund as they are afraid this might make them less eligible for financial aid. This, however, is just a myth. When it comes to financial aid for college, the government is far more concerned with your income rather than any savings you might have stored away.
4. What is my savings plan?
It is necessary to figure out an investment plan, or philosophy, to help make saving for college all the easier. You have to ask yourself if you are willing to contribute towards 100% of the college fund, or would you rather your child shoulder part of the responsibility. A popular strategy is to save up for one-third of the college fees, pay the next one-third out of your salary when your kid’s in college, and the remainder of it through federal loans.
5. Where do I invest and save?
- 529 Plans
When it comes to saving for college, 529 savings plan is often the right choice. Any income from these plans is free of capital and income gain taxes (if used to pay for higher education). The money grows tax-free. The returns from these 529 plans do not have to be withdrawn at a certain period. They can also be transferred to a different beneficiary, in case your child’s getting a scholarship.
- Roth IRA
Although mainly used to stash away money for retirement funds, Roth IRAs can be a great place to start saving for college. In this, you can make tax free withdrawals. Also, the contribution you make to it can be used for your retirement, if not for your kid’s college. Some financial planners recommend that you max out your Roth IRA and then start investing in a 529 plan.