Saving for College: Five Steps to Get You Started

Dear Carrie, 

My son is barely a year old but I know I should already be saving for college. It just seems so far in the future that I keep putting it off. Is there an easy way to get started?

—A Reader

Dear Reader,

As crazy as it seems, today's parents really need to start saving for college from day one. Costs are already high—and they're only going to get higher. In fact, if you take today's costs as reported by the College Board1 and assume an average 6% annual increase, a newborn today will need about $295,000 to pay for a 4-year in-state public university. Using the same calculation, a private school could cost well over $500,000.

But don't panic. If you start now, keep saving regularly and invest that money for potential growth, you'll be way ahead of most parents. The key is to put yourself on a savings program you can stick with. Here's a step-by-step to help you get going.

1. Get a Social Security number for your child ASAP. Often parents apply for a Social Security number for their child when they fill out the birth registration form. But if for some reason you don't yet have a Social Security number for your son, you can apply for one at your local Social Security office. You'll need this to open a College Savings Account (or any other type of bank account) on his behalf.

2. Open a 529 College Savings account. To me a 529 is one of the best ways to save. It's a state-sponsored savings plan, but you don't have to live in a particular state to qualify. However, your state plan may offer you a tax break, so start there. Also check with your bank or broker to see what they offer. Initial minimum contributions vary, but you can open some plans with as little as $25—sometimes even less. Collegsavings.org is a good resource for comparing plans.

The great thing about a 529 is that the money grows tax-free, and you don't pay income tax on withdrawals as long as they're used for qualified college expenses such as tuition, room, and board.2 (Be careful, because if you withdraw money for “nonqualified” expenses you will not only get hit with taxes on the earnings but likely have to pay a 10% penalty.) Depending on the plan, you can either invest the money yourself or choose a predetermined investment portfolio that will be managed for you.

With a predetermined portfolio, you'll usually have a choice between conservative, moderate or aggressive investment approaches, or what's called an aged-based portfolio that adjusts from aggressive to conservative as your child gets closer to college age. Whether you do your own investing or choose a portfolio that's managed for you, I'd start out investing as aggressively as you feel comfortable doing to help maximize potential growth. As your child gets closer to college age, it's wise to gradually decrease your level of risk.

3. Figure out how much you can save each month. A 529 is only as good as the money you put in. Look at your budget and come up with a realistic amount you can contribute each month—something you'll stick with. As your income grows, you can up the amount.

4. Put your 529 contributions on automatic. Consider setting up an automatic monthly payment from your checking account to the 529 and just consider it an essential part of your budget. You might also check with your employer to see if you can make contributions automatically as a payroll deduction.

5. Talk to the family. One of the pluses of a 529 is that anyone can contribute to it. So when family members or friends want to give your child a gift, suggest a 529 contribution. There's no annual limit on contributions—just a lifetime limit that is generally upwards of $200,000, depending on the plan.3

A special advantage is that an individual can contribute five years worth of contributions (up to $70,000 in 2013) to a 529 in a single year ($140,000 for a married couple) without paying a gift tax. (To qualify for this exclusion, you will need to file a gift tax return; then the IRS will consider it the equivalent of an annual $14,000 gift over five years.) This can be a great way for grandparents to make a significant contribution. Of course any additional contributions or gifts during the five year period would be subject to gift taxes.

Take off from here

This should give you a good start. As time goes on, you can look for other ways to save more. For instance, you might direct a portion of any bonuses or other windfalls to the account.

As your son gets older, you can also get him involved. For example, when he's able to get a part-time job, have him put a percentage of his earnings toward his education; likewise with monetary gifts. And remember, there are other ways to pay for college such as loans, grants and scholarships.

One caveat: Saving for college is important, but so is saving for retirement. Put what you can toward your son's education, but don't short-change yourself. Contributions to your 401(k) or IRA should come first. No one is going to give you a loan to help you retire!

1. Source: CollegeBoard.org
2. Qualified education expenses can include tuition, fees, books, supplies, equipment, and room and board. The earnings portion of a nonqualified withdrawal is subject to federal and state income tax and a 10% penalty. State tax treatment of earnings may vary. Check with your tax advisor for rules on your state’s tax treatment. The availability of tax or other benefits may be conditioned on meeting certain requirements, such as residency, purpose for or timing of distribution, or other factors.
3. To qualify for the special gift tax exclusion, you need to file a gift tax return to treat the gift as if it were made in equal payments over five years. To avoid gift tax, you should make no additional gifts to the beneficiary during those five years.

Next Steps

Important Disclosures

Before investing, carefully consider the plan's investment objectives, risks, charges and expenses. This information and more about the plan can be found in the disclosure statement or Participation Agreement available from your financial institution and should be read carefully before investing. As with any investment, it is possible to lose money by investing in a 529 plan.