smartly save for college

What are the costs

College costs have surged in the past several decades about as fast as any expenses families face. Parents who attended private colleges and paid tuition approaching $5,000 are now faced with tuition for their children amounting to 10 times that. If you look at a private college costing $40,000 a year in tuition, room, board and other fees and charges, you’re facing a bill of $160,000 over the four years. If graduate school is on the table, costs are almost unfathomable.

Attending public colleges and universities in your home state can relieve a significant amount of this expense. Many privates may offer students that have good academic records and test scores with enough aid to reduce expenses to roughly match the costs of the public institutions. Private colleges are generally very well-endowed and can afford to offer good deals to students they covet. According to the College Board*, total costs for a private college in the 2022-23 school year averaged $57,570, of which $39,400 was for tuition alone. In-state expenses at a public school averaged $27,940, of which $10,940 was for tuition. Public tuition for out-of-state students averaged $45,240. The major of choice could also be a factor. For example, at the University of Illinois at Urbana-Champaign, the tuition for an engineering major was $5,000 more than for other majors.

Prospects don’t appear to be getting better, unless, as some politicians predict, college education will eventually be paid by state or federal taxpayers. While we await developments in that direction, however, understand that forecasters see an education in a public college costing $200,000 in 18 years; in a private college, $400,000.

Start saving early

Nevertheless, no matter which college is chosen, it promises to present a daunting expense, now and into the future. As with any other sizable fund that must be accumulated, the earlier you start, the more that can be saved without fracturing a budget toward the end of the savings period. Experts say that a good college investment plan enacted at the time of the prospective student’s birth would cost about $325 a month. Waiting until the child is 10 years old to begin would then cost $650 a month.

So how does a parent accumulate what appears to be a vast sum of money for the education virtually all experts agree children will need over the next several decades? The widely preferred choices amount to two: a Coverdell Education Savings Account and the state-managed 529 plan, which is available in all states. Both allow for money to be put into an account, with varying degrees of risk and income potential, and tax-free interest earnings.

The Coverdell ESA differs from the 529 plan in that it is limited to an investment of $2,000 a year and that it can be used for education from kindergarten through college. Many families use it for private elementary, middle and high school. The 529 plan is for college only, and there is no annual contribution limit.

Each Coverdell ESA is for one student only, but families can have more than one ESA — one for each student. The investment is directed by the investor, which some people prefer. There is an income limit — $110,000 for an individual or $220,000 for a couple, the student must be under 18 years of age for investments to be made, and the account must be used by age 30.

As for a 529 plan, there is a wider latitude in several ways. The account itself is similar to a 401(k) or IRA. Money is invested by the individual and can be managed by either the state, according to various levels of aggressiveness, or by a financial adviser, though choosing the latter will add fees. State management is called direct-sold savings; using advisers is called broker-sold savings.

Amazingly, you don’t have to live in the state in which you have your 529 plan account. You can look up and compare each state’s fees and growth opportunities, such as at Collegesavings.org and Savingforcollege.com, to track the 529 plans.

Earnings in a 529 plan grow federal income tax deferred and will not be taxed when the money is taken out to pay for college-related expenses. The earnings may also be eligible for state tax deductions. However, when you contribute to a 529 plan, a gift tax may apply if your contributions to a particular beneficiary exceed $14,000 during the year. And any accumulation of savings not put toward college will be taxed upon withdrawal and a fee will be charged.

Use a 529 plan strictly for college tuition. Room, board, books — any college expense can be funded by the 529. However, if you wind up putting more into the fund than will be needed for college, withdrawals will be subject to taxes and a 10 percent penalty on interest earned.

If you had one child graduate and had 529 plan money left over, it could be transferred to another child’s account without penalty. Or, if the student wins scholarships or grants, a matching amount can be withdrawn from the account without cost.

If you do, for some reason, decide to withdraw money from the 529 plan and not use it for education, you will be taxed only on the interest earned — not the amount put in, since it was invested after taxes.

Although 529 plans are regarded as relatively safe investments, they are still investments, and some risk must be acknowledged. Reviewing the plan annually is critical to ensure that the funds are put to work based on the age of the student and how many years the student has before college.

It’s never too early to begin a Coverdell ESA or a 529 plan. Nor is it ever too late, though the later you start one, obviously, the less time it will allow for you to fulfill your needs. College is one of life’s most substantial but most important investments. Get it into your budget as soon as you can.