Updated: 9/15/2010 9:00 AM ET|
How to save for your kid's college
Your child's age, along with whether you're rich, poor or in between, will help determine how you should put aside money for school (and how much).
Many parents who invested in 529 college savings plans got a nasty shock in 2008, when some supposedly conservative plans plunged by 30% or more. Instead of preserving money that was about to be used for college expenses, these plans erased it.
State-run college savings programs are still a good option for many families. But the 2008 debacle highlighted the importance of picking the right savings strategy, monitoring it closely and taking an active role in your investments as college draws near.
The reality is that no single college savings method works well for every family. The right way for you, personally, to save for college depends on several factors, including:
- Your tax bracket.
- Your child's age.
- How much control you want over your investments.
- How much financial aid you expect your child to receive.
Many people don't realize that financial aid is based largely on income -- primarily that of the parents, but also that of the student.
(Assets matter, too: The typical college will want the student to spend 20% of his or her savings annually on college costs, while the parent is expected to pony up 5.6% of certain assets each year.)
Keep your expectations realistic
The best way to figure out how to save for college is to use your income, and your tax rate, as a guide. Before we get into a bracket-by-bracket rundown, though, there are a few caveats you should understand:
Caveat No. 1: The following breakdowns assume that your child is relatively young. If you've got five years or fewer until your first tuition bill comes due, you may want to skip the tax-deferred options, said Kathy Kristof, the author of "Taming the Tuition Tiger: Getting the Money to Graduate."
That's because you don't have enough time to earn much in the way of investment returns, so tax breaks on earnings are of little benefit. Saving in taxable accounts will give you more freedom, because you won't have to deal with the restrictions that come with tax-deferred accounts.
Caveat No. 2: Loans make up more than half of financial aid packages. So even if your savings reduce your ability to get financial aid for your child later, don't sweat it too much; you're simply sparing him or her future debt.
Caveat No. 3: These strategies assume the tax laws will remain pretty much the same until your kids are grown. That's a pretty big if. Should Congress make major changes, you'll need to revisit your strategies.
The lowest brackets
This includes folks in the 10% and 15% brackets, which for 2010 are those with taxable incomes up to:
- $34,000 for single filers.
- $45,500 for heads of household.
- $68,000 for those who are married filing jointly.
If you're in the lowest brackets, you don't benefit all that much from tax-deferred accounts because you don't pay very much income tax to start with. You also probably won't be able to save the huge amounts that might make tax deferral a better deal.
But you do have the best shot at getting significant financial aid. So your guiding principle should be to save in ways that don't mess with your child's ability to earn scholarships and grants later. Here are some do's and don'ts for your tax bracket:
Keep your savings in your own name. Parental assets weigh less heavily in financial aid calculations. Plus, you have the flexibility to use the money any way you want.
Consider beefing up your home equity or retirement savings. Most colleges don't count these assets at all. If your child makes it into an elite private school that does, you'll still be expected to spend only a small portion of these savings on his education.
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