The 6 Stages of College Savings


If you’re thinking about financing your child’s college education, there are a number of steps you can take right now, no matter what age your child is to help build the savings you’ll use for college.  Don’t fret about some of the outlandish college costs that we’re all seeing out there.  The price tag is daunting now, and it will be in the future, but the sooner you start, no matter what your capacity to save, the more you’ll have when the time comes.

Let’s look at the actions you can take during each stage of a child’s journey to college.

Get a goal and a plan 

Whether your child is age minus 9 months, or 16, knowing your end game, and what it will take to get you there is crucial.  Goals and plans drive action, and keep you focused on the activities you need to pursue to get you to your destination.  If you know the school you would like to see your child attend, that’s great. To figure out what the total cost for that school is now (every college has the costs of attendance on their website), use an online calculator to determine what four years of tuition and expenses will be when your child will be attending.  The College Board (the organization that administers the SAT exam) has a good College Cost Calculator available to estimate future expenses.  A school that costs $45,000 per year today for tuition, room and board, assuming a 3% inflation rate,  will cost $320,000 for a degree 18 years from now.  Before you pass out, know that many variables and time could impact that number, which is a worst-case scenario.  Although it would be nice to have the full amount, whatever amount you wind up with will mean less loans or out of pocket expenses when it comes time for college.   Who knows, maybe your future child will be an amazing athlete who gets several full-ride offers.  Regardless, pick a goal, figure out what it will cost you, then figure out what you’ll need to save monthly to reach you goal.  Click here for a calculator to help you figure all that out.

Pre-birth

If your intention is for your child to attend college and you’re able to get a head start, go right ahead.  There are several ways to fund a college education, but it’s difficult to set up some of the  traditional college savings vehicles until your child is born.  You can however create and fund a 529 college savings account with yourself as beneficiary.  Once the child has a social security number you can change the beneficiary.   You can also set up a bank or brokerage account in your name to make deposits into, and then move that money into a college savings vehicle once the child is born.

Birth 

The two tax advantaged accounts that are most widely used for college savings are the Coverdell ESA or Education Savings Account, and the 529 College Savings Plan.  They both work in a similar fashion, but there are some significant differences. For example, if you think your child may attend a private K-12 school instead of the public school system, the ESA is the only account of the two that can be used to pay for qualified K-12 expenses as well as college.   The ESA is very limited in the amount that can be contributed ($2,000 per year), and if you make too much money you may not be able to contribute at all, but the accounts earnings grow tax-deferred like a 529, and withdrawals for qualified educational expenses are tax-free.  529’s don’t have any income limits, and the contribution limits depend on the state, but they are significantly higher than the ESA, so you can stash a lot of cash (put those gifts from friends and family to work right away). Click here to read about the differences between 529’s and ESA’s.

At this stage, fund one or both accounts if you can, and invest fairly aggressively using diversified mutual funds or ETF’s with a weighting towards equities.  With college as the goal, you have 18 years to overcome the ups and downs that the stock market will bring. The S&P 500 index has never had an 18 year period where it had a negative return, even during the years of the Great Depression. In fact, it has averaged over 10% since 1926, so make sure stocks are part of your college savings portfolio at this stage.

Grade School Years

Establish regularly monthly contributions to a 529, and make it automatic through payroll or checking account deductions so you don’t even think about it. Continue contributing to an ESA if your income levels are below the modified adjusted gross income limits .  Some 529’s may have tax benefits depending on your state, so consider what opportunities you have to save and pick the appropriate accounts.  For example, NJ residents get no tax benefits for contributing to a 529, but Pennsylvania residents do.Continue to contribute to a portfolio exposed to stocks.  Even in middle school, there is still a significant amount of time.  Most 529 plans will have an age-based investment option that will automatically change the make-up of a portfolio of mutual funds that adjust over time so as the beneficiary nears college, the allocations become more conservative. It’s a good option for those who want to set it and forget it (although you should always review your statements to check your progress versus your goal).

These are also the years to assess Junior’s talents and abilities and potentially adjust your expectations for where he or she will wind up.  If your initial computation considered costs for your closest state school, but your daughter is clearly on track to be her class valedictorian, you might consider costs for your favorite Ivy to potentially adjust your strategy.

High School Years

Don’t stop.  If you’re contributing $200 a month and earn 7% through your child’s high school years, that’s $11,000 more in your college coiffures. If your portfolio is in an age-based strategy, you won’t have to do anything.  Your portfolio will be adjusted to a more conservative mix likely with more fixed income investments than equities. If you’re adjusting it yourself, you don’t need to sell everything and go to all cash once your child graduates high school. Remember, college will last four years, and potentially longer.  That said, if you have all your college costs saved (perhaps your child received a nice scholarship), then putting the portfolio in all cash investments would be prudent.

College Years

At this point, it should be clear if you’re able to fund the college expenses that you intended.  If you’re going to be short, you have some options.  You can apply for student loans.  The first stop would be the school’s financial aid office to explain your situation and get the application process started.  There are several types of federal, state and private loan options to choose from.   You can also fund out of your cash flow or savings, which generally isn’t optimal since those monies are probably earmarked for other purposes. Another less optimal option is your retirement accounts.  Withdrawals from IRA’s are permitted, if used for qualified educational expenses. You’ll may still owe taxes depending on the type of account, but you won’t incur any penalties.   Most financial advisors will recommend against using your IRA’s, since you can get loans for college and you can’t get loans for retirement.

If your accounts are over funded, that’s a good problem to have.  Money in 529’s can be in there forever, whereas an ESA needs to be spent by the time the beneficiary is 30 years old. You can also change the beneficiary of a 529 to a family member of the beneficiary, such as another child, yourself, or a future grandchild. You can change generally change an ESA’s beneficiary, but you should check the account agreement to make sure it is permitted, and of course you can’t name a new beneficiary who is over 30 years old.  If you need the money at some point from either type of account, you can withdrawal it for whatever purpose you want, however if it’s not a qualified educational expense, you’ll pay taxes and a 10% penalty on the earnings portion of the withdrawal. That is not the worst thing in world considering you could have had 18 years of tax deferred growth in the account.  ESA’s must be used for the initial beneficiary