With some private college tuitions topping $50,000 per year, it can take decades to save for college before school and pay the final bill after graduation. But thanks to benefits in the tax code, saving specifically for college and other education expense can have some advantages. There are a variety of specialized accounts and investment vehicles to know when planning your college savings.
Don't let the numbers or acronyms intimidate you. Here's how to save for college effectively:
Consider your savings vehicle. Whatever you choose, consider the fees, potential returns, investment options and your tolerance for risk.
- 529 College Savings Plans. Provided by the states, 529 plans offer tax-free growth for investments, from emerging market stock funds to cash-like accounts. There are no federal taxes on withdrawal if the funds are used specifically for tuition, room, board and others expenses. Many states also offer tax deductions for contributions. When selecting a 529, start with your own state, which may have benefits only for in-state investors.
- Bank accounts. Some families prefer traditional bank-based savings accounts. You'll never lose money, but there are no tax breaks. And if interest rates are low, your savings will mostly increase only by what you put in.
- Other accounts. Other options include a custodial bank or brokerage account, with no tax advantage, opened on behalf of a child or a Coverdell Education Savings Account. Through 2012, the contribution limit for a Coverdell is $2,000 per year per child; withdrawals aren't taxed if used for qualified education expenses.
Start saving now. Regular contributions are the least painful way to save and add the benefit of compounding returns.
- Auto-pilot. You can make automatic deposits from your paycheck or bank account into a 529 college savings plan or other account. If the contribution is on auto-pilot, you are less likely to skip it.
- Rally the family. Encourage grandparents and other family members to contribute to an account instead of buying toys and clothes. Anyone can give up to $13,000, or $26,000 per couple, without adverse tax and estate effects. Better yet, in donating to an in-state 529, you might even get a tax break.
Never give up. Keep saving even if you are already paying for college. And invest appropriately if you have loans on the other side.
- Get your kids involved. More than half of teens expect to contribute some cash to their college costs. Encourage them to get a summer or part-time job and start saving.
- Make sure the risk is right. Unlike the uncertainty that surrounds retirement saving, there are finite costs associated with college. Figure out how much your family would be expected to contribute and reassess the risk level of your investments. The closer you are to needing your education saving, the more money you may want to put in less risky investments such as bonds, money market funds or cash.
- Call the school. Contact the financial aid office at potential schools. You may be surprised. Many private colleges offer generous grants which could make the cost lower than a public university.
What not to do when saving for college.
- Don't overlook scholarships. Even if you've saved, it's worth applying, especially if you or your child has a special interest or talent.
- Don't crack your retirement nest egg. It's a tempting pot of money but a bad choice. Students can borrow or attend another school. Retirees don't have those choices
For more reading, numerous sites provide college cost calculators and information on savings vehicles. These include www.savingforcollege.com, which follows college savings vehicles including 529 college savings plans, www.collegeboard.com, which provides information on everything from college planning to college entrance exams and www.fastweb.com , a web site with information on savings, college life and financial aid. Also read if consolidating student loans makes sense; try our 529 plan calculator for college savings, and read about the best student loan options from the government.