Parenting is a lot like investing. Think about it. Your kids are like little bank accounts. You regularly deposit your time and love into them and watch your investment grow and mature. Sometimes, you have to reassess your investment strategy…maybe you need to diversify your portfolio by targeting piano lessons or hiring a tutor (awesome metaphor, no? <takes a bow>). And as important as it is to nurture our kids, sometimes, we want to give them something a little more liquid than love and support…like…well…money.
Saving Money For Your Munchkins Series
Chances are you want to set aside money for your child to use in the future. Like with all savings goals, the first question you have to answer is this: what do you ultimately want to see happen with the money you save for your child?
There are several motivations you might have to save money for your children. A popular reason to save money, and the main topic of today’s post, is saving for college. But that’s not the only reason you might want to sock away some money for your munchkin. Here are a few others:
- Saving For Adulthood Boost
- Saving For Retirement
- Saving For A Rainy Day
I’m going to dedicate the next couple of posts of how to save money for your children for the future. Today, we’re going to focus on one of the most popular motivations most parents have when it comes to saving money for their children, saving money for college.
How Do I Know How Much To Save For College?
Trying to figure out how much money you should set aside in savings for higher education isn’t exactly the easiest figure to come to. None of us own a crystal ball that can tell us what the future holds in regards to our children as they approach college age. So, your best bet s to try to get a ballpark figure to help guide your savings and make sure you find the right vehicle (read: savings approach) to grow your money over time (read: return on investment or interest).
As with any goal, you’ve got to start by narrowing your objective. Here are some questions you need to ask yourself to help you determine how much you’re going to need to save for college:
- How many children are you planning to send to college?
- How much time do you have left to save for college?
- What type of college/university? In-state or out of state? Public or Private?
- How much school are you covering? Undergrad? Graduate school? Professional School?
- What costs are you covering? Tuition and fees? Room? Meal Plan? Books?
Still feeling clueless as to what it is going to cost you to send your munchkins to school? The College Board has a very informative page dedicated to helping parents calculate what it costs to go to college.
Okay, So Where Do I Put My College Savings?
There are several products out there that you can use to save money for your child’s college education. Here are a few of the most popular:
Option 1: Savings Account or U.S. Savings Bonds
If you’re really risk averse, you may find yourself tempted to set aside college savings in a traditional savings account or by purchasing U.S. Savings Bonds. Granted, these accounts are safe, as in they do preserve your principle deposits (what you put in is at least what you pull out), but there’s always a price for shying away from risk.
Currently, the interest rates on savings accounts is…well…garbage. Interest rates aren’t even keeping up with the rate of inflation, which does not make a savings account the ideal place for long term growth. Savings accounts are the perfect tool for emergency savings or short term savings, but definitely not long term.
U.S. Savings bonds series EE and I can be used for college savings, but also come with some significant hiccups. Series EE and I bonds can only be used towards tuition and, as with other college savings, any non-qualified withdrawal will result in a 10% penalty on the amount withdrawn.
Option 2: UGMA/UTMA
The Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) are like the ancestors of the whole college savings account craze. Well before college costs began to spiral out of control and 529s and ESAs became popular, UGMA/UTMA accounts were the savings vehicle of choice. They still serve a great purpose for, say, grandparents or high-income families, to set aside money for the newer generation, but aren’t as popular as a college savings tool today.
UGMA/UTMA accounts are, however, a great option for saving for a little kick-start nest egg for your children as they approach adulthood.
My main beef with this type of account is that the UGMA/UTMAs are custodial accounts, which means that once your kiddo reaches the age of majority for your state of residency, the account becomes your child’s asset (read: theirs, not yours to control).
Not that any of our kids would do this, but just the thought of the girls having the potential access to dip into their college savings to put towards a new car or road trip or whatever else young adult minds can concoct, is just not kosher with me. <shiver>
Option 3: Coverdell ESA
The Coverdell ESA (Educational Savings Plan) is a curious creature. The neat thing about this type of account is that you can use it for both K-12 and higher education costs, which is really neat if you are facing the prospect of saving for private, public, or religious K-12 education, but it has some real limitations as a vehicle to save for college.
The Coverdell Account has a $2000 deposit cap per year…TOTAL. Regardless of how many accounts (read: kids) you have, you can only sock away two grand. And like with most college savings accounts, any withdrawal applied towards non-qualified expenses is penalized at a rate of 10%.
Interested in learning more? The IRS has a great summary about CSAs.
Option 4: 529 Plan
529 Plans are my personal fave and college savings tool of choice.
There are two common types of 529 Plans:
- Prepaid 529 Plans: contracts purchased to lock in today’s tuition rate at public and some private colleges in a particular state.
- 529 Savings Plan: systematic investing plan rooted in mutual funds that grow tax free and can be used for any qualified higher educational expense.
These plans require as little as $25 to open the account and have an investment cap of $300,000.
Tax Advantages of 529 Plans:
529 Plans are investments that are exempt from capital gains tax. Also, when you withdraw from your 529 for a qualified educational expense, it is not taxed as income either. If you decide to invest in a 529 plan in your state of residence, you may be eligible for tax rebates on contributions made to these plans (something to keep in mind when doing military tax preparation).
If you are a resident of a state without income tax or one that does NOT offer a tax incentive, I encourage you to check Morningstar’s Best 529 Plans of 2012. I’m happy to say that the state we use has been a top performer since 2006! Woot! Woot!
Option 5: Military Family Perk, Post 9/11 GI Bill
I’m working on this section to provide you with the best information I can! Stay tuned!
Retirement First
I know you get tired of hearing me say this, but always put your current financial savings needs first! If you are not actively working on establishing your emergency savings account or fully funding your retirement savings, fuggedaboutit. Always, always, always put yourself before the college savings because nobody wants Mom and Dad to crash at their pad because they neglected to save for their golden years.
College savings image from Tax Credits’ Flickr stream.
What are your savings goals when it comes to your kids? Got any burning questions? Drop them below!
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