The Golden Rule for College Savings: Start Early!

Once the initial excitement of welcoming a new child or grandchild into the world has passed, the realization that this bundle of joy comes with a high price tag begins to set in. Beyond diapers and daycare, the single highest expense parents are likely to incur is a college education.

It is a grim fact that since 1983, college tuition has risen at a rate vastly higher than the cost of living. This poses a big challenge for families trying to pay for higher education.

While there is no silver bullet, there are actions you can take to make the cost of a higher education for your children and grandchildren more affordable.

THE EARLY BIRD CATCHES THE WORM

Foremost, families must start early in order to take advantage of the benefit of compounding as well as to allow for a more aggressive investment strategy and a higher potential return.

A $10,000 investment for a newborn will grow to $40,000 by age 18 assuming an 8% return. Wait five years to start and the $10,000 only grows to $27,000. Automatic monthly savings plans are an excellent way to improve the likelihood of saving consistently.

CHOOSE AN OPTIMAL SAVINGS VEHICLE

In addition to starting early, the optimal college savings vehicle should minimize fees and taxes. In the previous example, $10,000 saved in a tax sheltered account means that the full $40,000 can be spent on education, while non-sheltered savings will shrink to $28,500 after taxes are paid.

Among the three popular college savings vehicles, 529 College Savings Plans and Coverdell Education Savings Accounts (ESAs) score the highest in terms of tax savings, while UGMA/ UTMA (Custodial) accounts are the most flexible.

529 accounts offer low starting minimums, high contribution limits, tax free growth (if used for higher education) and beneficiary flexibility, and are an especially good option if you start when your child is young.

A Coverdell account offers many of the same benefits as a 529 but with income eligibility limits and significantly lower contribution levels. Unlike the 529, Coverdell proceeds can be used for primary and secondary education.

Custodial accounts have no contribution limits and do not have to be used for education. However, control of a custodial account passes to the child at his or her age of majority which in most states is 18. Custodial accounts offer limited tax savings for beneficiaries under the age of 23.

In each case, there is value in segregating college savings from other assets, as it helps families focus on the progress being made towards the goal and reduces the likelihood it will be used for another purpose.

COLLEGE SAVINGS AND FINANCIAL AID

A note about financial aid and college savings: assets that belong to the student result in a greater reduction in financial aid. Custodial accounts are counted as the student’s asset. 529 plans and Coverdell ESAs may be better options to save for college without jeopardizing financial aid. Financial aid is a complex subject, and colleges often view assets differently than the federal government. Special assistance in navigating the financial aid process is recommended.

GET THE FAMILY INVOLVED

In addition, college savings can be a family affair. Parents are expected to contribute a far greater percentage of their income today than ever before. When family members and friends ask what they can give your child to celebrate a birthday or holiday, encourage them to give the gift of education by contributing to your child’s college savings.

The consequence of failing to save is severe: having to forego college or not being able to attend the college of choice, and/or a large debt load. Borrowing exacerbates the already high cost of education. If we fail to save $10,000 at birth, and need to borrow $40,000 at 18, it will cost$55,000 in total (if paid back over 10 years at current rates of 6.8%).

The optimal college saving solution may incorporate several strategies and the best advice is to set a goal, make a plan and get started!

Kerry B. Connell, CFP®

Kerry joined HTG in 2014. She helps clients create a picture of their financial goals and directs investments to attain those goals. Kerry is also involved in the firm’s management and strategic planning initiatives and contributes to HTG’s educational and networking efforts.

Kerry is a CERTIFIED FINANCIAL PLANNER™ practitioner. She has a BA degree from Tufts University and an MBA/JD from Northwestern University.