Author bio: Ksenia Yudina is the Founder and CEO of UNest, the first mobile app that makes it easier than ever before for parents to save for their children’s future. Ksenia is an entrepreneur and financial expert with over ten years of experience in the financial industry. As a wealth manager she helped affluent parents access smarter saving and investment options. She founded UNest to extend the same financial acumen to parents across all income levels and backgrounds. To date, UNest has helped tens of thousands of parents save millions of dollars for their kids’ future.
College for my kids? Ways away, right? They may still be newborns or toddlers but the earlier you set your kids up for success the better. That’s why implementing a plan today is essential. College Board.org, a not-for-profit organization, published research showing the trends in college tuition costs dating back to 1989 revealing that over the past 40 years, college tuition rates have been constantly increasing at two to three times the rate of inflation each year.
It’s simple, saving for college over time makes infinitely more sense than borrowing and paying it off later. When you’re saving, your money earns interest; when you borrow, you’re charged interest. Every dollar saved is one less dollar you have left in student loans. Together, we can set your children up for a bright future and also work to eliminate the $1.7 trillion student debt crisis.
1. Define Your Goal
Before you get moving on a savings plan for your child, you have to define success. How much will they need? What is the time horizon? Use a free college calculator to help better understand the money you will need to send your kids to college.
Once you have an idea of what your college savings goal looks like you can create a savings timeline to reach your goal. It can help to set monthly or even weekly goals. Hitting these smaller goals at regular intervals will help you keep up continuous contributions for your child.
2. Understand your Options
Having a strong understanding of the options available to you will give you the confidence to choose the correct path to achieve your goals. Below are the most common options for saving and investing for your child.
If you go this route and your child does not go to college, you can use the money to meet another financial priority, such as retirement. However, the greatest drawback to saving for college with savings accounts is that they typically earn low-interest rates and may take significantly longer to reach your college savings goals.
529 College Savings Plan
529 college savings plans are one of the most popular college savings options. 529 plan earnings can grow tax-free and won’t be taxed when you choose to withdraw funds, as long as you use them for qualifying college expenses.
While a 529 college savings plan is similar to a Roth IRA, there are no limits to how much you can contribute each year. You may save as much as you’d like until your account reaches a certain balance, which is usually $400,000 or more. 529 plans offer age-based investment options that can make saving for college simple yet effective. You may get a tax break or credit for contributing to a 529 college savings plan.
Unfortunately, if your child doesn’t end up going to college and you don’t have another child to transfer the funds to, you’ll be on the hook for taxes and a 10% penalty fee.
A Coverdell ESA is similar to a 529 plan in that it can help you ensure your savings are used for tuition, books, room and board, and other college-related costs. When you withdraw from a Coverdell ESA, you won’t have to pay any federal taxes on it, as long as you use the money on qualified expenses.
Although the Coverdell ESA may be a good option, it’s essential to understand its restrictions. It will only allow you to contribute up to $2,000 per year per child. Since the cost of higher education is increasing every year, saving $2,000 per year for 18 years or a total of $36,000 may not be enough to cover a lot of your child’s college expenses.
If you’re unsure whether your child will attend college but still want to save for their future, a custodial account can be a great option. Two of the most common custodial accounts include UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act).
There are no restrictions on how you can use the funds of a custodial account. The only caveat is that the money needs to benefit your child in some way. Custodial accounts also offer tax breaks. While the initial $1,000 is tax-free, the second $1,000 is taxed at your child’s income tax rate, and the remaining is taxed at your income tax rate. Once your child turns 18, you won’t be able to tell them what to do with the funds.
3. Begin Early
Families who start as early as when their child is born will accrue a much more significant amount of their savings from earned on investments. For example, if you take a family who starts saving for their child’s college when their baby is born, roughly a third of the savings will come from earnings alone.
For parents who wait until their child is already in high school to create a child college savings plan, less than 10% of the money in the account will come from earnings.
Suppose you want to be proactive in saving for your child’s future. In that case, you can get started even sooner to reap the most tax-advantaged benefits of establishing a bank account for child education—when they’re just a baby or even before they’re born.
4. Set it and Forget it
Automating your savings is one of the easiest ways to save even more and reach your savings goals, but what does it mean to automate your savings, exactly? You, the contributor, will make automatic and fixed amount deposits at specified periods into an account.
Every time you receive a paycheck, you can set a designated amount automatically transferred to your accounts. Automating your savings is not only convenient but can also help with budgeting and managing your spending habits. Automating your savings also helps take the emotion out of investing in a plan or portfolio that can increase or decrease depending on the market performance.
5. Leverage Best Practices
Below are a few investing best practices that can help you increase the value and impact of your savings plan:
Dollar-cost averaging is a strategy in which an investor places a fixed dollar amount into a given investment (usually common stock) regularly. The investment generally takes place each month regardless of what is occurring in the financial markets. If you have been committing money monthly to a 529 plan, you will likely see that portfolio dip because of the recessions. It is vital to continue investing now; otherwise, dollar-cost averaging won’t work for you. Furthermore, during a recession, you should consider increasing your monthly allocation.
Diversification is the act of, or the result of, achieving variety. In finance and investment planning, portfolio diversification is the risk management strategy of combining various assets to reduce the overall risk of an investment portfolio. Purpose of Portfolio Diversification The goal of portfolio diversification is portfolio risk management. A risk management plan should include diversification rules that are strictly followed.
Age-based portfolios are ready-made portfolios that adjust based upon your child’s age. That means, when your child is younger, your portfolio may include aggressive investments with a higher potential for growth and risk.