Saving for college: The Child Tax Credit and tips for new parents
For many parents, the idea of setting aside savings for their young child’s college education on top of all their family’s current essential financial needs can feel like a daunting task. But it doesn't have to be, and here’s why. You don’t need to plan on saving to pay the full sticker price for your child’s education.
According to Sallie Mae’s How America Pays for College 2021, families use multiple sources to cover costs. “Free money” from grants and scholarships usually covers about 25% of the costs, and parent and student loans cover another 20%, leaving a bit over half of college costs to be covered by parent and student savings and current income.
Where should I start?
While it may not seem like a priority to save for a baby’s college education, the right time to start saving is now. A recent study from the College Savings Foundation’s Annual State of College Savings caught my eye. According to their survey, 58% of parents are planning to use part or all of their payments from the U.S. government’s current expansion of their Child Tax Credit (part of the American Rescue Plan of 2021) to save for their child’s higher education. Those advanced payments could be as much as $300 per qualifying child under age 18.
For parents who can afford to do so, earmarking that money for college could be a good start to help buttress their savings for higher education.
How should I save?
Of the parents planning to use the tax credit to save for their child’s higher education, the majority (72%) plan to contribute to a 529 Education Savings Plan. A 529 Education Savings Plan is a great way to save for your child’s higher education:
- Any growth of the money you save in a 529 education savings account is tax-deferred.
- Distributions are tax-free when used for qualified expenses. Qualified expenses go beyond tuition and related fees and include room and board, which could be as much as or more than tuition.
- ·You may receive a state income tax deduction or other state benefits for your contributions.
- You can use money from your 529 account to cover the costs of nearly any college across the country. You aren’t limited to colleges within your state.
How much 'college' can $300 a month buy?
While the current expansion of the child tax credit is set to expire at the end of 2021, we suggest continuing to save as much as you’re able to in your child’s 529 plan account because $300 a month can really add up over time. Many college savings calculators default to total published sticker prices for higher education. Covering total costs, considering no other funding sources (such as grants, scholarships, and loans), results in sticker shock and anxiety for many parents.
Consider this example, however, by starting contributions when your child is one until age 18 and changing the funding goal to 50% of total college costs. That $300 a month contribution fully funds the goal for a public four-year in-state school and improves the outlook at a private, nonprofit four-year school.
Source: T. Rowe Price College Savings Calculator. Hypothetical 6% average rate of return and 5% college cost inflation rate. For illustration purposes only and does not reflect any actual investment product.
Aiming to save half of future college costs may be a reasonable plan
Consider it a down payment on your child’s college education. Grants and scholarships, coupled with reasonable debt (i.e., limiting student debt to federal student loans), may cover about half the total costs, meaning that the savings you’ve set aside in your 529 account could cover the rest. As your child gets to high school, and prior to first-year orientation, however, you’ll want to reassess your situation, consider specific school choices, and scour financial aid packages to make a plan that works best for your family.