College. That single word can lift a parent’s spirits and send an icy jolt of fear down their spine at the same time. A college education can play a huge role in a child’s chance for career and financial success, but the price tag can be breathtaking (and not in a good way).
According to the College Board, the average tuition at a private school was $31,231 for the 2014 – 2015 year. Even a state school will set in-state students back $9,139 a year on average. Thinking about the cost of your child’s future college expenses can be painful, but that’s all the more reason to start planning as early as possible.
Starting Planning for College Now
When it comes to saving and investing for college for your children, you must first answer two important questions:
- When will you need it?
- How much are you going to need?
You can reasonably guess when your child will graduate high school, but it is nearly impossible to know how much your child’s college costs are going to be. Will your child go to a state school or a private school? Will he or she earn a partial scholarship to help defray costs? What if your child goes to community college firsts or needs five years to graduate instead of four?
Your best bet is to assume a “worst case scenario” of sorts. In other words, what is the most your children could possibly need? As you do the math, keep in mind that college costs rise an average of 6% each year!
You’ll probably come up with a scary number, but remember it’s better to plan for the worst and then be pleasantly surprised if your child chooses a state school or receives a scholarship!
Longer Time Frames Suggest Greater Risk Pays
If the child you’re planning for is eight years or younger – meaning there’s at least 10 years before he/she matriculates – stocks should definitely be part of your investment mix. Given that college costs have risen on average of about 6% a year for the last 25 years, it makes sense to try to get at least that long-term compound rate of return. That will probably only be possible if stocks make up a significant portion of your education portfolio mix.
As with any portfolio, as you get closer to the date you need to begin spending the funds, the more conservative you should become.
Section 529 Accounts vs. UGMAs and UTMAs
When you start looking at vehicles to save for your child’s college education, you’ll find that you have several options. Your best option is likely to be a 529 account, which is funded with after-tax contributions and grow tax deferred. All withdrawals for eligible education expenses are tax free. Unless you are investing in tax-free bonds, the tax advantages of a section 529 account are considerable. (Read about how 529s aren’t just for your kids.)
All 50 states and the District of Columbia sponsor section 529 plans, and many of them offer different features, including types of investment options and expense ratios. It pays to shop around, because by law, you can invest in plans sponsored in other jurisdictions.
Before the advent of section 529 plans in 1996, parents and grandparents typically opened UGMA (Uniform Gifts to Minors) or UTMA (Uniform Transfers to Minors) accounts. Compared to section 529 accounts, these have several disadvantages. They are subject to income and capital gains taxes (although at the minor’s rates), and the assets revert to the child’s control once he/she reaches the age of majority. Since these account are held in the child’s name, 20% of the assets will be considered available by financial aid officials for covering college expenses. In contrast, just 5.6% of nonretirement assets held in the name of a parent are considered available to pay for college.
Now that you’ve learned a little about college savings, it’s time to contact your financial advisor and start asking about your 529 options. You can also learn more about how money affects families and relationships in our article archives.