College Savings

How Much Should I Save for My Childs College Education?

As the cost of tuition keeps going up every year, refugee parents should think of the possibility of saving money for their children’s college. Refugees and immigrants need more help in this area. CFL conducts workshops to help parents of refugee children understand this process.

The first thing you should do is find out how much college will likely cost for your child when they will be attending. Use this number as a worst-case scenario because it is likely that your child will be able to receive some small scholarships or other forms of financial aid.

Start Saving Early

How much money you are saving is less important than how soon you begin saving. Compound interest is a wonderful thing and the longer your money has to grow, the more it will grow. When you begin saving and investing early on that money goes to work for you so that you don’t have to save as much. Take a look at these examples to illustrate the power of compounding over time:

  • Begin investing $5,000 each year when your child is 10 in an account that earns 11% annually. This would result in a total savings of over $65,000 by the time they are 18. Total money invested: $40,000.
  • Begin investing $2,000 each year when your child is 8 in an account that earns 11% annually. This would result in a total savings of over $37,000 by the time they are 18. Total money invested: $20,000.
  • Begin investing $3,000 each year when your child is born in an account that earns 11% annually. This would result in a total savings of over $148,000 by the time they are 18. Total money invested: $51,000.

As you can see, if you begin investing as soon as possible you could save less money annually and only $11,000 more in total than if you waited 10 years and end up with $83,000 more!

Assumptions

In these examples we used an annual return of 11% which comes from the average annual return of the broad stock market. Some years will return more while others will return less. These numbers are for illustration purposes and do not take into account additional tax savings or credits that can be obtained when using tax-favored college savings accounts.

With college expenses soaring, more and more parents are trying to offset some of the cost by putting money aside to help pay for their child’s education. In 1996 the 529 plans were created to provide some tax benefits for those who are trying to save money for higher education.

How a 529 Plan Works

529 plans are state-sponsored and specific details can vary slightly across each state, but the underlying principle is that these plans allow individuals to save and invest money and provide tax benefits if the funds are used for higher education expenses. Similar to IRAs, they usually allow you to invest in money markets, stocks, bonds, and mutual funds.

529 plans allow individuals to make significant contributions into the plan. In some states, they allow for contributions of over $200,000. Even with such a high contribution limit, you need to be aware of the annual gift tax limit ($12,000 or $24,000 when a joint contribution is made).

A one-time lump sum contribution of five years’ worth can be made and bypass the gift tax provided no additional contributions are made during those five years. All contributions are then invested and grow tax deferred.

Finally, when it is time to begin taking distributions from the account, provided the funds are used for a qualified educational expense as defined by the plan, the withdrawals are tax free. Similar to an IRA, if the distributions are not qualified, the earnings would be subject to taxes in addition to a 10% penalty.

Additional Benefits

While you are generally able to participate in any of the 529 plans, there may be an added benefit to take part in the plan where you reside. Some states actually allow some contributions to be tax deductible. So, not only does your money grow tax deferred and possibly tax free, but you may be able to receive a tax deduction on some contributions as well.

Another feature that can make a 529 plan attractive is the flexibility of changing beneficiaries. If the child that the plan was set up for doesn’t attend college or doesn’t use all of the money inside the plan, the plan can be assigned to another beneficiary.

Some Drawbacks

Since these plans allow you to invest the money just as you would for retirement, it also means there is some market risk. With any investment, there is a chance that your holdings could decline in value.