How to Save For Your Child’s Education

Our little girl is 4 months old (time is flying!). We want to make sure she has a quality college education when she grows up, and what better way to do that than to put some money aside today that could grow into a large sum in the future?

But how on earth does one save for a child’s education? Do you simply put money into:

  • a savings account?
  • savings bonds?
  • stocks?
  • a money market account?

There are so many options, it can really be quite terrifying to decide what to do. Because of this, many people simply do nothing. They fully intended to put something toward their child’s education, but suddenly, in the blink of an eye, their son is 18 years old and there are only two options for him:

  1. Take on a massive amount of student loan debt, or
  2. Don’t go to school

DO NOT BE THIS PARENT. If you have a child and you want to help them with college tuition, then learn how to save for your child’s education and then START TODAY!

How to Save For Your Child’s Education

Yes, you could save for your child’s education with a savings account, with savings bonds, with stocks, or with a money market account. But are these the best options? Without going into laborious detail, the simple answer is “no”.

save for your child's retirementSo what other ways are there to save for your child’s education?

For most states, there are two methods:

  1. A pre-paid tuition purchase plan
  2. A college-direct investment account

Both of these options are referred to as 529 plans, but they are actually quite different in practice.

1) Pre-Paid Tuition Purchase Plan

Pre-paid tuition plans are exactly what they sound like. You pay for your child’s education today so that they can go to college for free at a future date.

In Michigan, these plans are called MET’s (Michigan Education Trust). When you put money into this trust, you’re purchasing college credit hours at today’s price. With this particular plan, you pay a rate of $571 per credit hour. Put $571 into the account this year and your child gets a free credit hour when he/she starts school. Invest $1,713 today and you’ll earn your child a 3-credit class.

It’s pretty straightforward, but there are definite downsides to this plan.

First, these pre-paid state plans are often only good for your state. If Junior decides that he wants to go to school in Maryland, then all that saving you did was for nothing because the money can’t be used out of state.

Second, the pre-paid credit hours only save you from tuition inflation. In other words, by paying today you’re avoiding paying more later (because college costs are sure to go up), which sounds like a wise move until you consider that the tuition inflation rate is estimated to be 5% or less, and a market investment could yield you more than 10%.

Third, this plan only covers the cost of tuition. Books, room and board, and supplies need to be covered out of pocket.

In short, the MET is better than a putting your money into a savings or money market account, but there are definitely limitations here. So many, in fact, that I never recommend this option to my friends or family.

save for your child's education2) College Directed Investment Account

Almost every state offers this second option, which is a college-directed investment account. It’s almost like a 401k for your child’s education. You simply invest the money, decide what type of funds you put your dollars into, and then watch it grow!

In Michigan, this fund is called a MESP (Michigan Education Savings Program). You can start a fund today for just $25. It only takes 15 minutes to fill out (I’m actually funding Addi’s college fund right now!) and you can even set up automatic withdrawals (here’s the form) so you don’t have to mail in a check every month.

While this fund will likely give you more bang for you buck (vs. the pre-paid option), there is a major risk involved: There’s no guarantee that you’ll earn money in a College Directed Investment Account. In fact, you could actually lose money here because the fund rises and falls with the stock market.

It sounds scary, BUT you have to remember that you’re investing over the course of 15 years or more and it is INCREDIBLY unlikely that the stock market will be down for 15 years straight. More than likely, you’ll earn 8% or more over the course of your investment, which is why I typically recommend this method to save for your child’s education.

Why You Should Save For Your Child’s Education Today

So why am I jumping all over you to start investing for your kid’s college education? Is it because I’m being paid by MET or MESP? Definitely not. I am earning ZERO DOLLARS to write this article.

I want you to save for your child’s education for FIVE reasons and all of the reasons benefit YOU.

  1. It grow tax free – Your initial contributions aren’t tax deductible at a federal level, but the earnings will never be taxed, which is an amazing benefit, especially when you’re talking about tens of thousands of dollars in growth!
  2. You won’t be able to save more later – Kid’s only get more expensive as they get older. If you don’t start contributing today, then you almost certainly won’t find the money to do it later either.
  3. Compound Interest – The earlier you start, the more compound interest you’ll earn. Case and point: Invest $10,000 today, it will be worth $40,000 in 18 years. Invest $10,000 when your kid is 8, and it will only turn into $21,500.
  4. It only takes $25 – Everyone has $25, which means no one has an excuse. Isn’t your child’s future worth twenty-five bucks?
  5. It’s easy to put off – Contributing to a college savings plan is kind of like writing out your will. You don’t quite know how to do it, and it sounds like absolutely no fun to tackle…so you put it off. DO NOT put this off. Save some money for your kids! You won’t regret it!

Will you begin to save for your child’s education?

 

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9 comments to How to Save For Your Child’s Education

  • We’ve started saving for my daughter (who is 6) last year. My son just turned one so we are going to get on the ball earlier and start saving for him as well. We went with Merrill Lynch’s 529 account for ours.
    Latoya @ Life and a Budget recently posted..Reader Question: Who Can Really Help Us With Our Student Loan Debt?

  • We started saving with a 529 plan, but I am thinking about switching strategies in a few years. Our boys (now 8 and 7) have a business selling duck eggs. Plus we own rentals and I let them do some paid work on the properties. I am considering having them earn more money as they get older, file taxes and open a Roth IRA for them. I want them to have the chance to go to college, but also the worth ethic that will make them successful no matter what they do. I think they might feel more ownership (even if I am just matching what they earned, and they get to spend their earnings.)

    • Sounds like an awesome plan! Liz and I aren’t going to try to fully fund our kid’s college either. They’ll have to work for some of it. I love the idea of having them work on your rental properties! Sounds like an amazing learning experience!

  • Dottie

    I believe our 529 only allowed deductions from our state taxes. (Virginia)

    Also, there are federal tax CREDITS (always better than a deduction) of up to $2500 that you may be able to take if you use up to $4000 (for tuition only) in what I call “other funds”….not in the 529 plans or saving bonds, etc. You can’t double dip, so these funds need to be saved in a mutual fund or other account.

    Believe me….with 2 boys in the middle of all this, I try to find every break I can! I do my own taxes so I try to keep up with all this. If you use a 529 or other tax advantage account ONLY to pay for college bills, you may miss out on other tax savings. Your accountant may not tell you about it until after the fact, or at all.

    • I hadn’t heard of the $2,500 tax credit, Dottie! That sounds perfect for our plan of funding some of their education through a 529, and some via our rental property income. Thanks for the comment!

  • Kathy

    I started saving for our son’s college almost as soon as he was conceived. I faithfully contributed to it every month, even if it was only $25. I used a variety of savings vehicles including CDs, mutual funds, Uniform Gift to Minors accounts and even old fashioned passbook savings. As our income increased, we increased the contribution. Our son helped as well by working summers, qualifying for scholarships and working at a paid internship he found completely on his own. (What a smart kid I raised!!) 529 plans were not available than so they didn’t factor into the equation. The final accounting was that we had enough money to pay for his education through his Masters degree….all without any student loans.

  • […] daughter Addi is 6 months old. We opened a 529 fund a couple of months ago and currently have $350 in it. Obviously I didn’t fool myself into […]

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