When today’s 10 year olds hit college age, a four-year degree at a state college will cost $150,000 to $175,000 on average. That’s a big chunk of change for most people, so the earlier you start the better.
First off, parents have to think about what kind of college they’ll be able to afford. “Be realistic: Can you afford a state school? A regional college?” asks Dave Morgan, a Raymond James financial advisor in Naples, Fla. There are many online resources to help parents figure out how much money they need to put away. Yahoo Finance, Money magazine and large mutual fund companies all have them, he says.
Once you’ve figured out how much you need to save, it’s time to pick a savings vehicle. Many parents opt for a college savings account called a 529 plan, named for the Internal Revenue Service code that created them in 1996. “529 money grows tax free and you can take it out tax free, so long as you’re spending the money on education,” says Colleen Schon, a Raymond James advisor in Auburn Hills, Mich. “That’s what I encourage 99% of my clients to do.”
You can put a lot into a 529 plan — $13,000 per year per individual, so Mom, Dad, Grampy and whomever else wants to contribute has a pretty high annual cap. What’s more, grandparents can contribute a lump sum of as much as $65,000, or five years’ worth. “This is a great idea, because that interest will compound,” Schon says, which means your interest earns interest after the first year, adding to your pot.
For parents going it alone, “you’ll need to contribute $1,000 or more per month, something most parents can’t afford, especially in this economy,” Schon says. If you’re able to save $100 or $200 per month, at least that’s something, but your child will likely need to take out a student loan too.
When choosing a 529, the first decision is whether you pick an in-state plan, benefiting from a state tax deduction, or whether you’ll get better performance in an out-of-state 529 plan even without the state tax deduction. “Check out your local plan and also what companies like American Funds, Fidelity, Franklin Templeton and Vanguard are doing,” Schon suggests. “Do a comparison and pick a fund family that meets your risk tolerance and time horizon.”
Morgan adds that parents should be wary of counting too much on an expected rate of return to add to their child’s college fund. “Anyone saving diligently over the past decade may now have less than they put in,” he says. “Everyone models for 4% or 5% growth rate but you might not get that.” To maximize your chances, increase risk when your child is younger and decrease it when she’s in high school, regardless of what the market is doing. “You can’t let fear or greed drive your decisions,” Morgan says.
If you’re a little short, don’t be afraid to ask a college for help, he adds. “Talk to the college about how you don’t have enough money but you’ve got a great kid. You’d be surprised, but that can work!”