by Daniel Boylan, Instructor of Finance, Ball State University
Helping students minimize student debt is a goal for many parents. Nationally, about 16% of college is paid for by parents. In these economic times, saving smart is a better idea than ever before. But how can parents help their children pay for college? College expenses are the second largest purchase of a person’s life (second to the purchase of a home) so just like any other big purchase, some thought should go into how it will be paid for.
Putting money away in savings vehicles that have stronger investment returns, for example, is going to give you more bang for your buck than investments with weaker returns. Let’s say you saved $1,000 into an account with returns of 6%. At the end of the year, the account would grow to $1,060. In contrast, an account with only 3% returns would only grow to $1,030 over a year. Choosing to save with tax-advantaged investments can also prove to help parents save more up front. Suppose you saved enough to see investment returns of $1,000 in a year, and had a marginal tax rate of 25%. Having that savings in a tax-deferred vehicle would mean that rather than paying 25% tax on that gain and only seeing $750 of that return go into the following year’s savings, the saver would see the full $1,000. While it may seem prudent to get those taxes out of the way, the miracle of compound interest will speed up the growth of that savings over time.
The savings vehicle that may help you find strong investment returns and take advantage of tax-deferred savings is the 529 Savings Plan – and it’s perfect for parents! A 529 Savings Plan is a tax-deferred account offered in every state and the District of Columbia, allowing parents to defer taxes and grow accounts fast. 529s have the added benefit of being direct deposit friendly; you can easily set up an amount to be automatically deducted from your paycheck, making the act of savings easy.
Many 529 Savings Plans are designed to be “age based.” This means that when the student is younger the investments are more aggressive. As the account ages and the time for using the funds for college comes closer, the funds move into more conservative investments. This is helpful as the aggressive (or more risky) investments should be rewarded with a higher return. When a student gets closer to using the money, the investments are modified with more stable investments.
Naturally, starting sooner is more advantageous than saving later. Having 10 years of savings is better than two not only because of the amount of time available to actually save money, but the additional compounding interest will be significantly higher as well. And, of course, saving is a game of “the more the merrier.” Saving small amounts consistently throughout the year is good, but it is better to save more if you can.
It is never too early or too late to start a savings plan. Check out the recent blog post from America Saves to find out if a 529 plan is the right savings tool for you or visit www.scholars-choice.com to learn more about college savings.