Thanks largely to COVID-19, the cost of higher education actually went down a little going into 2021 — but it’s still not exactly cheap. The average cost of tuition and related fees for a ranked private college or university in 2020-21 is $35,087. That’s 72% more than an in-state public college, which averages $9,687. In between are out-of-state public colleges, which charge an average of $21,184 — that’s per year, by the way, not in total. Those are scary numbers for the average family, but saving for education doesn’t have to be an impossible climb. Here’s a primer to get you started
Because of the miracle of compound interest, time is an investor’s greatest ally — and saving for college is no different. The more time you spend contributing to your education fund, the more time your investments will have to appreciate in value and the bigger your returns will be in the end. No matter your circumstance, the best time to start saving is as soon as humanly possible.
Don’t Go Broke While You’re Doing It
Saving for college is important, but not so much that you should do it at the expense of everything else. Don’t neglect your own retirement savings, your emergency fund, your household budget or any other critical pieces of your financial puzzle. Make college savings a priority, but not the only one.
Save in an Account Tailored For Education
The government encourages education saving by granting tax advantages to certain kinds of accounts, most notably 529 plans. There are several types of accounts, however, that you can use to save for college, most of which you can open just like any investment account with any brokerage firm. Some are exclusively for education saving. Others can serve that purpose, too, but are more versatile and can also double as retirement funds or regular investment vehicles. Each has benefits and drawbacks that are too complex to expand on here in detail, and each is designed for different kinds of savers with different goals, priorities and strategies. Research all of them before you decide. The most common options are:
- 529 plan: One of the best and most popular ways to save for college, 529 accounts are subject to neither state nor federal taxes. You can contribute as much as $15,000 per account per year without incurring the gift tax.
- Roth IRA: Unlike traditional IRAs, Roth IRA contributions are from after-tax money. That makes them much more flexible. You can make withdrawals from them before retirement — including to pay for college — without paying taxes or penalties.
- Coverdell ESA: Coverdell education savings accounts are similar to 529 plans, but come with a much lower maximum contribution of $2,000.
- Prepaid plan: Some states allow you to lock in tuition rates at today’s costs for a child’s future education. Instead of saving, you’re actually paying tuition as your child grows and that tuition rate will never increase. Since tuition is almost always on the rise, these plans can lead to incredible savings over time.
- Custodial accounts: Custodial accounts allow parents to save money in a special account that’s taxed at the much lower child’s tax rate. In most states, the child can withdraw this money tax-free upon turning 18 or 21, even if it’s not for education.
- Savings bonds: The government sells savings bonds, which are one of the safest investments on the market. With less risk, however, comes lower rates of return.