By Julie Ford
This is part three of our college series. In the last article, I told you that the 529 plans are a great way to save for college. This week, let’s get into the details of deciding how much money you actually need to save for your kids' college education.
If you need a reminder, a 529 plan is a tax-advantaged savings account for college funds. As long as the money in it is eventually used for qualified educational expenses, your contributions to the account will grow tax-free, and some states will also give you a tax break on the contribution itself. A 529 plan also doesn't ding your federal financial aid eligibility as much as other accounts where you could keep college savings.
What's the catch?
A 529 is a great tool. You just want to be sure that you don't save too much in it.
There are actually penalties if you use the money in a 529 account for things other than "qualified education expenses." To avoid the penalties, you don't want to contribute more to the plan than you could reasonably expect to spend on these qualified expenses. The 529 funds are intended to cover tuition and fees that are required for college enrollment. This article provides a rundown on what does and does not qualify.
(One exception here is if your child gets a scholarship - in that case, you can withdraw money from the 529 for non-education expenses without the penalty. Here's a list of other exceptions to the penalty for unused funds.)
Another thing to note is gift taxes. Uncle Sam will charge you a “gift tax” if you give any one person more than $14,000 as a gift in 2016. A contribution to a 529 plan is considered a gift to the beneficiary for gift tax purposes, so make sure each parent doesn't give more than that per child per year, whether in a 529 or other account.
Now, let's figure out how much you should actually set aside in your college fund.
Step #1: How much will college cost?
First, it's a good idea to get a ballpark figure of what tuition might cost for your kids. This tool will let you estimate what you would pay at a particular college this year. It shows you the sticker price of tuition and expenses and the “net price”, or what the average student actually ends up paying based on income level after scholarships, grants and financial aid are factored in (spoiler alert: net price is often much lower).
If you don't know which school to choose, look up pricing for a public school near you and use that as a conservative, good-enough guess.
Step #2: How much do you want to provide?
If that number makes your head spin, think about this idea: You don't have to pay for 100% of your kids' college expenses! Sharing the burden of their education expenses can actually give your kids some helpful "hardship" or, in other words, teach them financial responsibility early on.
Step two in deciding how much to set aside for college is to decide what portion of your kids' college expenses you want to cover. This is a philosophical and completely personal decision. If you want to fund 100%, that's great. But don't feel pressured. Consider contributing 50% or less for each child if 100% isn't feasible.
Step #3: Create a savings plan
At the end of the day, remember that the most important thing is to focus on the habit of saving rather than the actual amount you’re able to save ($20 or $200 a month, whatever fits in your budget). As I pointed out in the first article of this series, there are a lot of other big priorities that come before college savings. But if you want to know how much to save to reach your college fund goal, here's what you do.
Once you have good assumptions for the current-year price of college per child, and how much you want to cover, you can plug those numbers into this calculator to see what you should be saving every month or year for each child. You'll also need to input how much you already have saved (you calculated this already in part two of this series).
Alternatively, here's a general rule of thumb on how much to save: Just contribute enough to get the full benefit of the state tax deduction, if you are using your state's plan and your state allows for an income tax deduction. This might not get you all the way to covering the full cost of college, but you'll make a really big dent for your kids. For a lot of states this would mean contributing up to $5,000 per contributor or $10,000 per contributing couple per year.
This week, go through the steps I just laid out:
- Get a good estimate for the annual cost of college if your kids were enrolled today.
- Decide how much you would like to contribute to those expenses.
- Use the calculator above to determine what you need to be saving each month or year for each child. Compare this to what you've historically been contributing to your 529 plan(s), and decide if you want to make a change to that amount.
Coming up next as the last article in this college savings series: I'll tell you what to do with your 529 until the time comes for your kids to head off to college.