Student Loans

How to Save for Your Child’s College Education

How To Save for Your Child's College Education | www.TheHeavyPurse.comMy oldest daughter, Lauren, is 9 years old and we talk about money regularly. These are not sit-down lectures where she struggles to stay awake, but every day conversations where we dialogue with one another, so I can instill healthy money habits and beliefs in her. One question I regularly ask her is, “Why is important to get good grades?”

Her answer? “So I can get into a good college and get a good job.”

This answer didn’t happen by chance. We frequently talk about college and the opportunities it represents, and I also make sure she understands attending college is something she has to earn.

College Savings Investment Options

While Lauren is busy hitting the books, I am busy saving money to help finance her college education, which many of you are doing as well, so let’s take a look at some of the different college-savings vehicles available.

529 Plans

Congress created 529 plans in 1996 and they are qualified tuition programs or a college savings vehicle with federal tax advantages. There are two types: college savings plans and prepaid tuition plans. The IRS has a great question and answer guide to 529 plans, which you can find here.

Advantages: They are flexible, which helps when you don’t know exactly how much money you need to save for education. For example; my oldest daughter is 9 and my youngest is 7. I have overfunded my oldest daughter’s account, not because I think she is smarter but because she will be the first child who may attend college. If she does receive scholarships/grants or decides not to go to college, I can change the beneficiary to my youngest daughter. If they both graduate from college and there is still money left in their 529 Plans, I can use it for my grandchildren’s education, or use the money to go back to school for my PhD!

Like most tax advantage vehicles, there are lots of moving parts, so please read through the IRS Q&A before investing. Be aware there is investment risk involved. You should sit down with your financial advisor and walk through the investments with your risk tolerance and timeframe in mind. There are fees and expenses with 529 Plans and penalties for non-qualified withdrawals.

Coverdell ESA

A Coverdell ESA is a tax-advantaged savings vehicle that lets you save money for qualified education expenses of a named beneficiary. Qualified education expenses include colleges expenses and certain elementary and secondary school expenses (advantage to Coverdell, 529 Plans only allows qualified college expenses).

The annual contribution limit is $2000 per beneficiary, which is considerably less than you can contribute to most 529 plans. The other drawback is depending on your earned income for the year, your contribution amount may be gradually phased out. The age of the beneficiary also limits the use of a Coverdell ESA, so you cannot make contributions for anyone 18 or older.

You can find more information on Coverdell ESAs here.

UGMA/UTMA—Unified Gifts to Minors Account/Unified Trust to Minors Account

Before 1996 these were the most popular way to save for children’s education. They are a gift to a child, which then grows and is taxed at the child’s rate (referred to as the kiddie tax). Due to this tax advantage they became very popular.

Advantage: They are flexible. Unlike the 529 and Coverdell ESA savings plans, the money can be used however the child pleases. If they do not go to college, the money can used as a down payment for a home or to pay for a child’s medical expenses without penalties.

Disadvantage: In my opinion — ownership. This money becomes the child’s upon reaching the age of majority (18 or 21 depending on the state). I cannot tell you how many parents have begged me to not let their children know this money is available or theirs at 18 or 21. The reality is the account is legally the child’s (now a new adult) and they are the account owner. Another disadvantage is this money is in the child’s name, so when it comes to federal financial aid calculations, it is considered the child’s resources for college and can influence the amount they are eligible for.

BE AWARE: 529 Plans, Coverdell ESAs and UGMA/UTMAs are complex. There are many more details that cannot be covered in a blog post and may be very important to your personal situation, so please consult your financial advisor to discuss which option is right for you.

Other Ways to Save or Pay for College

Let’s take a closer look at some other options available and weigh their pros and cons.

Scholarships/Grants

I see two major mistakes that parents make in this area.

  1. Counting on the child winning a scholarship or grant and not saving for college (assuming parents want to help pay). 
  2. Not finding every scholarship/grant available and applying for everything! 

My husband spent hours applying for everything he could and won several scholarships and grants, ultimately only needing $5,000 in student loans, which he paid off within a year of graduation. This would have not been possible if he had not spend countless hours researching and applying for every grant and scholarship available to him.

401k Loans

I often hear parents say they will take a loan from their 401k since this is often the largest savings outside of their homes. There are many concerns I have with this. A couple considerations:

Paying for College from Cash Flow

It is hard for most parents to pay for college from cash flow and there is usually a reason why you were not able to save for college in the first place. Promising your child that you will pay from cash flow is, in my opinion, a mistake. After you go through your budget and know how much you can safely contribute (without going into debt or falling short on other goals, such as retirement) then do so.

Some Final Thoughts

Please remember, there is no universal rule that requires you to pay for college. Many very successful people put themselves through college and lived to tell the tale. Let go of the guilt and show your love by helping them find every scholarship and grant available and apply for all of them. There is also nothing wrong with a child getting a job to help cover some of the costs themselves. And if they still need student loans, then help them create a plan to tackle that debt after graduation.

Shannon

The Heavy Purse Store is now open! My new downloadable Money Club Workbooks are now on sale. Each workbook provides five targeted lessons to help you raise Financially Confident Kids. Please check them out in The Heavy Purse Store.

Photos courtesy of www.freedigitalphotos.net.

May 22, 2013  •  35 Comments  •  Student Loans

Leave a Comment

Comments

  1. Wednesday, May 22nd, 2013
    We chose to do the state 529 plan for both of our kids. We did so because our state offers a 20 percent tax credit on the first 5K contributed in any year.
    • Wednesday, May 22nd, 2013
      Not every state offers a tax credit, so that's wonderful yours does, Holly. It's definitely a nice perk!
  2. Wednesday, May 22nd, 2013
    Great info Shannon! I want to do a 529 plan for my daughter. Do you have any recommendations? :)
    • Wednesday, May 22nd, 2013
      Thanks, Mackenzie! There are a variety of 529 Plans available in California and I'm sure there is one right for your daughter. If you have a financial advisor, s/he should be able to help guide through all the various plans. Otherwise, shoot me an email and we can talk offline.
  3. Wednesday, May 22nd, 2013
    Great breakdown Shannon! There are some good options out there and it just requires some homework to determine which is right for your specific situation. We have UGMA's for our kids, but will likely be changing that in the near future and just need to sit down and determine what is the best option for us.
    • Wednesday, May 22nd, 2013
      Thanks, John! Parents definitely need to do their homework, but there are plenty of options available to them, which is good news. UGMAs were incredibly popular at one time, but the ownership issue can be problematic. :) I'm sure you and your wife will figure out the best plan for your kids.
  4. Wednesday, May 22nd, 2013
    We've got a 529 for my son. We don't get a tax break in MA, which is unfortunate, but we still like that option. We're not saving a ton for college yet but hope to build up over time. Retirement is definitely the priority for us. I was extremely lucky to have my parents pay for college, but I think the scholarship aspect is an overlooked one. That's something I feel like I should have taken better advantage of and will definitely encourage my kids to use, though I won't be counting on it.
    • Wednesday, May 22nd, 2013
      A little bit adds up quickly with time. I agree that scholarships are overlooked and I'm not sure why. The internet makes it easier than ever to find and apply for them. Certainly you can't count on receiving them but you should try for as many as possible. They can make a huge difference!
  5. Wednesday, May 22nd, 2013
    Great review on all of the options that are available. I have a question about the 529 plan. If your girls for example do not require it for which ever reason, does the money have to be used for someone's education? The example you used is that you might use it or you may leave it for your grandchildren to use for school. Is that your only option for those designated funds or could you use it to fund something else?
    • Wednesday, May 22nd, 2013
      Thanks, Sicorra. Yes, the money in a 529 Plan does have to be used for college to avoid withdrawal penalties. However, you can change beneficiaries to whomever you chose. So for example, I could change it to myself or my husband. A niece or nephew. Or even someone I don't know, but want to help fund their higher education.
  6. Wednesday, May 22nd, 2013
    Well done Shannon. We went with a 529 plan because of the state tax benefits. I realize that the funds have to be used for college, but if my son gets a full ride or pays for it on his own, then I wouldn't mind paying the fees to pull the money out. That would be a great gift to have, minus the fees!
    • Wednesday, May 22nd, 2013
      I agree, Grayson! And if your son is fortunate to receive a full ride, then you can chose to give him a gift too - and pass along his original college funds to his future children.
  7. Wednesday, May 22nd, 2013
    Great to hear about her successful education in this respect! Hope she can also find a nuanced and healthy definition of "good" to go along with that.
    • Wednesday, May 22nd, 2013
      Me too, Mike. I tell her a good job is one that she is passionate about and fulfills her, but also provides an income that allows her to create the life she wants too. She doesn't know what her passion is yet, but she understands how it correlates to being happy in her job and that you need to earn money to do things you love, like traveling.
  8. Wednesday, May 22nd, 2013
    I am not sure I would get a 529 because you have to use it for college, so what if even your grandchildren don't want to go because by 2050 college is obsolete?
    I would focus on scholarships the most, and also early college credits, they are so cheap, plus if you graduate a year early that is a whole year worth of rent and living expenses you save.
    • Wednesday, May 22nd, 2013
      There are definitely ways to help minimize college costs that should be taken advantage of, whenever possible. What I think is most important is parents align how and what they want to pay for their children's college education and communicate with their child what family resources will available to help them.
  9. Wednesday, May 22nd, 2013
    Wow...you are going for your PhD? Nice! We chose to go the 529 route for the flexibility like you mentioned. It is a great benefit to be able to change the beneficiary. But we are also counting on scholarships and will be doing loads of research on that in the next few years.
    • Wednesday, May 22nd, 2013
      Well, I'm not hitting the books yet...it's a future dream and one that I would certainly fund with my daughter's 529 Plans if there is any money leftover. Right now life is a little too hectic, but definitely some day I'd like to get my PhD. Yes–definitely take the time to find as many scholarships as possible to apply for. It takes a little work, but any money that doesn't have to come out of your pocket - is well worth it!
  10. Wednesday, May 22nd, 2013
    I don't understand your American account options but here in Canada we have a registered education savings plan (RESP)which you can open the day they get their SIN card. We opened one for our daughter when she was 5 weeks old and made it quite clear that we would much rather have the $10 here and $20 there to stash away in her savings than a house full of toys and stuffed animals. Everyone gets a 20% match by the government (if you're in a low income bracket you can get upwards of 40% match) to a max of $7200 lifetime.
    • Thursday, May 23rd, 2013
      It looks like Canada has a great savings plan for college. And I agree, toys and stuffed animals are nice, but you only need so many. Slipping the extra money into their college savings account is a much better investment! :)
  11. Thursday, May 23rd, 2013
    Great info. Definitely going to pass this along. We started saving for all my kids as soon as they had a social security number, and they know this. We've taken them to college campuses, and talk about the importance of a college education. I think it's important to plant those seeds young. Who knows if we'll have enough, but at least there will be something to work with. And if they have to pay for some as well, I think it's good to have them have some skin in the game too. :)
    • Thursday, May 23rd, 2013
      Thanks, Kerry! I think it's important for kids to understand how you're using your family resources to benefit them and the responsibilities that requires from them. Our daughters know we are saving for their college education too. There is definitely nothing wrong with the kids having a little skin the game either. It can certainly help them from taking their good fortune for granted when they have to help cover some of the expenses.
  12. Thursday, May 23rd, 2013
    Hey Shannon,

    Thanks so much for sharing this information with us. This is great stuff. I have two kids who are getting ready for college and these programs will definitely come in handy :)

    There certainly are lots of options out there for us to look into. Thanks again Lady :)
    • Friday, May 24th, 2013
      You're welcome, Corina! There are definitely plenty of options available to help finance college for your kids. Have a wonderful holiday weekend!
  13. Thursday, May 23rd, 2013
    I have been stashing away at least $10 a week for my son so that by the time he is old enough to go to university he will have at least a small amount to help him out on that path.

    Obviously $10 a week isn't much and it will never pay for a degree, but it is a start and once the mortgage is gone I plan on increasing this investment in his future quite substantially.
    • Friday, May 24th, 2013
      It may not be much, but it's a great start and has time to grow since your son is just a baby. :) It will definitely put a good-sized dent in his college tuition!
  14. Saturday, May 25th, 2013
    I have never even HEARD of UGMA/UTMAs before! Great post!
    • Tuesday, May 28th, 2013
      Thanks! UGMA/UTMAs were incredibly popular but were eclipsed by the 529 Plans once they became available. The ownership issue makes them a bit problematic for most parents.
  15. Greg @ Thriftgenuity.com
    Tuesday, May 28th, 2013
    Solid advice and things that I will keep in mind while raising children. Regarding scholarships, although I won't plan on them, I might split any money left over in my kids' college account if there is any due to scholarships they earned. Will have to wait and see how that goes when the day comes.
    • Tuesday, May 28th, 2013
      Thanks, Greg. Sounds a like a great idea to motivate your child to apply for all the scholarships and grants available to them!
  16. Wednesday, May 29th, 2013
    Great, comprehensive write-up. I'd add that this would have been a great guide for me to follow in saving up for my own education while I was waiting to go back to school :)
    • Wednesday, May 29th, 2013
      Thanks, Mario! While I appreciate the relative ease of getting student loans, I also think their convenience cause people to overlook saving and other funding options, like scholarships and grants.
  17. Saturday, June 20th, 2015
    That really an amazing article speaking about the grades earning. Your conversation is really inspiring and interesting. Every mom and daughter should be friendly and mom should guide the children in the proper way. Every children will answer in the same way which your daughter have answered. They go to school to earn the credits for going college and employ ability.
Shannon Ryan SHANNON RYAN, CFP®
  • Meet Shannon

    "As a Certified Financial Planner, it is my passion to help individuals and families build a healthy relationship with money. I look forward to helping you raise financially confident kids.” - Shannon Ryan
Facebook Twitter YouTube