Saving for your kids' education? The sooner the better

If you’re a young parent, one of the greatest challenges you will likely face in building a brighter future for your children is to find a way to help them afford higher education. One of the best solutions of course, is to have a pool of money saved to help pay at least some college expenses. If you value post-secondary education for your children, this should be one of your top financial priorities, along with the need to save for your own retirement.

The realities of higher education costs

In general, the cost of college continues to rise faster than inflation. According to the National Center for Education Statistics (NCES), in the decade ending with the 2010-2011 school year (the last year data was provided for by the NCES), tuition, room and board at a four year public university rose 46 percent. During that same period, the broad inflation rate, based on the Consumer Price Index, rose just 27 percent. Applying this to actual costs, the average cost for four years at an in-state public university for 2010-2011 was more than $62,000. If inflation trends continue, four years at a public university could cost more than $130,000 for a child born today.

Combine those startling figures with the fact that the most widely available form of financial aid to students today is in the form of loans. Grant and scholarship aid may be limited, and more readily available to students with a demonstrated financial need.

Start early and stick with it

The best strategy to build a college fund is to start it as early as possible with a regular savings program. Some parents choose to set aside a portion of their income each month for just that purpose as soon as a child is born, or even earlier. This gives them the ultimate advantage of the time value of money.

For example, saving $300 per month in a college savings plan for a child beginning at birth and earning an average annual return of 7 percent (no fees or taxes are assumed) will build an education fund valued at nearly $130,000 by the child's 18th birthday. In essence, the parents had to save just half of that amount, about $65,000, to accumulate what was needed to cover the potential future cost of four years of college.

The high cost of waiting

If your child is now five years of age or older, you've lost some valuable time but still have an opportunity to save a significant sum in a similar fashion. But to accumulate close to $130,000 for college by the time the child turns 18 (under the same circumstances outlined above) will require savings of $510 per month.

Wait until your child is ten years old to begin saving, and you must set aside $670 per month to achieve a similar result. As these examples show, the burden of saving becomes much more severe if you put off starting an education funding strategy.

Depending on your circumstances, it’s not always reasonable to be able to save regularly over the course of your child’s pre-adult lifetime. If your child is a teenager and you’re just beginning to save, here are a few suggestions:

•     Save what you can reasonably afford to put away for your child’s college fund, but don’t sacrifice entirely your retirement savings in the process. Your child can borrow for education, but there are no grants or loans to help afford your retirement.

•     Whenever you begin saving, consider using a tax-advantaged approach, such as a 529 college savings plan that allows earnings to grow tax deferred and the tax-free withdrawal of funds for qualified education expenses.

•     If you or your child’s grandparents have the resources available, family can make a gift in one year of up to $70,000 ($140,000 for a couple who consent to split the gift) in 2013, five times the annual gift tax exclusion, to a 529 with no gift tax consequences to the gift.1

•     When the time comes to pay for college, take advantage of any available tax benefit to reduce the net cost of college to you. For example, today’s American Opportunity Tax Credit (available in its current form until 2018) offers up to a $2,500 credit for qualified college expenses.

•     Have a realistic discussion with your children about what to expect in their selection of a college. If money is limited, they may have to scale back their choices to more affordable schools or geographical areas.

No matter how close to college your children may be, the reality is that it will almost certainly require a significant investment. Consider working with a financial advisor who can help you determine the best way, based on your goals and situation, to save for your kids’ future education.

Paul Fragala, CFP®, CIMA®, is a Private Wealth Advisor with Ameriprise Financial Services, Inc. in Andover, MA.  He specializes in fee-based financial planning and asset management strategies and has been in practice for 19 years. To contact him: www.paulfragala.com, 76 Main St., Andover, MA, (978)-474-9900.

 1 A person who chooses to take full advantage of the five-year spread for 529 plans would not be able to give additional gifts to that person during the five-year period without filing a gift tax return, unless the gift tax exclusion were increased, such as through an inflation adjustment.

Ameriprise Financial and its representatives do not provide tax or legal advice. Consult with your tax advisor or attorney regarding specific tax issues.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

© 2013 Ameriprise Financial, Inc. All rights reserved.                  File # 72912