The cost of higher education seems to spiral upward every year. Here's what you need to do to be financially prepared when your child heads to college.
The average cost of earning a four-year degree could top $205,000 by 2030, according to some estimates. Amassing that kind of cash takes time, so it's important to begin saving as early as possible, perhaps even right after each child's birth. The combination of consistent saving, compound interest and investment returns can add up to significant growth over the years.
While any investment can be earmarked for college expenses, some savings accounts are designed for this purpose and can provide tax advantages as well:
Run by states or schools, 529 plans let you save for a kid's college costs with the money's earnings growing tax-free. While there's no deduction from federal taxes for contributions, that benefit is fully or partially provided by many states. There are no income or contribution limits, but the money has to be used for a designated beneficiary's education expenses. Also, gift taxes may apply if you contribute more than $14,000, including any other gifts, to the recipient in a given year.
Coverdell Education Savings Accounts
Formerly known as Education IRAs, Coverdell Education Savings Accounts are trust funds that pay qualifying education expenses for a designated beneficiary. Contribute up to $2,000 annually until the beneficiary turns 18, then use all funds for education before the child reaches 30 years and 30 days old.
Contributions aren't tax-deductible, but interest and returns earned are tax-free as long as the money is used for qualified educational expenses. To be eligible, your taxable income must be under $110,000, or $220,00 for those filing jointly.
Invest by age
Saving for college parallels retirement planning in that an aggressive investment portfolio, weighted with growth stocks, is recommended during early years with a shift to more conservative assets such as municipal bonds as the time approaches to start withdrawals. Start with equity and stock index funds and begin to adjust the mix once your child turns 9 by putting new contributions into less volatile things like muni bond funds. At 14, begin moving the money out of equities to beef up bond holdings, and aim to be completely out of stocks and equity funds by the time your child starts college.
Better late than never
Saving from an early age is best, but what if you missed that chance? These strategies can help you catch up:
To reduce costs, consider enrolling your child in a community college for the freshman and sophomore years
Explore available grants and scholarships (studentaid.ed.gov/sa/types/grants-scholarships)
Keep adding to 529 plans after college expenses start
Have your child check out work-study and part-time campus jobs
Federal student loans can provide more favorable rates than private lenders
Further stretch your dollars by taking advantage of education tax credits. To avoid being disqualified, pay the first $4,000 of qualified college expense out of pocket before tapping into 529 funds. With a little planning, research and creativity, your child can earn that diploma while you keep your financial health intact.
© Copyright 2016 NerdWallet (www.nerdwallet.com), Inc. All Rights Reserved