Saving for college is an important but often overlooked area of the financial planning process for new parents. It is understandable that new parents are overwhelmed with all the drastic changes that have uprooted their former lifestyle. Because the parents of babies and toddlers are often concerned with making it through the night, it is difficult to focus on what will happen two weeks down the road. However, time goes by quickly. With the blink of an eye, your child is suddenly five years old. (For related reading, see: New Parents: A Financial Planning Checklist.)
When it comes time to pay for college tuition, those five years of not putting money aside for college could potentially mean thousands of lost dollars in earnings and interest. For many parents, saving for retirement may seem like a more crucial priority, so they put off establishing a college savings account until their retirement finances are in better shape.
No matter how special the talents and attributes of your children, sometimes scholarships may not be an option. Many people know how much college costs today and are aware that college inflation runs higher than consumer inflation: at a rate between 6-7%. However, a greater number of people remain unaware of what these numbers will look like when their child turns 18 and is ready to take on the world as a first-year college student. (For related reading, see College Tuition: 8 Mistakes Parents Should Avoid.)
Here are two scenarios, both are financial models of college costs if your child is born today:
College #1 annual tuition costs $25,000 and College #2 costs $50,000 in today’s dollars.
In 18 years, based on 6% inflation, College #1 will cost $71,358 per year and College #2 will cost $142,716 per year. For four years of tuition, College #1 will cost $281,455 and College #2 will cost $624,332.
Let’s break it down on a monthly basis with an investment growth rate of 7%. To pay for College #1, if you start saving at your child’s birth you will have to put aside $653 a month for 18 years. However, if you are unable to save during the first five years, the monthly number will almost double to $1,111 and nearly double again to $2,195 monthly if you don't start until your child’s tenth birthday.
For #2 the monthly savings are as follows: $1,295 per month for 18 years, $2,202 per month over 13 years and $4,350 per month if saving over just eight years. (For more, see Should Parents Save Towards College or Retirement? )
529 Plans: A Prudent Solution
As you can see, by delaying saving for your child’s college fund, you will pay a hefty price to catch up. In fact, you cannot start too early when it comes to planning for your child’s college tuition. You can even open a 529 plan without having children. Parents can be the owner and beneficiary at the same time, and once your child is born you then make him or her the beneficiary. Also, talk to your child's grandparents, as you might be surprised to find out how willing they may be to make a contribution toward their grandchildren’s future.
The 529 plan is an excellent tool for putting money aside for college. Because cash saved and earned in a 529 plan is considered an asset of the parents, money can be withdrawn tax-free if it is used for college, and the beneficiaries can be changed without penalties along the way. Whether your child ends up receiving a scholarship, or does not go to college at all, any original contributions to the 529 plan can be withdrawn without penalty. Only the earnings will be taxed as ordinary income and receive a 10% penalty. (For related reading, see: There's More to 529 Plans Than the Tax Benefits.)
If you are interested in opening and investing in a 529 plan, it is always recommended to talk to your trusted financial planner to discuss how to allocate money, and how this will fit into your overall financial plan. You can also visit www.savingforcollege.com to review 529 plans to find more specific information for all 50 states.
The Bottom Line
Financial planning can be confusing and overwhelming, with many intricate elements that need to be reviewed and adjusted as our lives evolve. Hopefully this article will prompt you to take action so that you can plan your child’s future as early as possible.