According to a study done by Fidelity, 42% of parents wish they started saving for college earlier. While saving for college can seem like a daunting challenge, we’re here to help.
If you’re wondering when you should start saving for your child’s college education, you’re in the right place. Keep reading to learn about when you should start that college fund, how much money you should save, and what college savings options you have.
When Parents Should Start Saving for College
The cost of college tuition rises annually due to inflation. In fact, between 1980 and 2020, the cost of tuition rose by 169%. So, it’s important that parents start saving for college as early as possible.
That said, experts advise that worries about the “when” should not hinder parents from saving now. Annette VanderLinde, the Chief Client Officer for Portfolio Solutions, states that, “Either there’s too much stress placed upon opening a college savings account right after birth, or regret in not starting a savings account earlier. The key is to just get started and let go of the worry.”
Whether your child is six or sixteen, you should be looking into options and saving for college as soon as possible.
It is important to note that parents who begin saving later will have to contribute more money than parents who began saving earlier to “catch up.” Parents who begin saving earlier have time and compound interest on their side, meaning that their gains may be substantially larger.
>> MORE: Learn more about when parents should start saving for college
What to Do If You’re Getting a Late Start on Saving
If you are starting late on saving for college, it may be smarter to take on less risk as market fluctuations can be a detrimental player to your college savings goal. Perhaps it would be wiser to look into more safe, secure investments or age-based plans.
If you don’t reach sufficient savings, you should look into the different types of financial aid for college. Additionally, you can use Sparrow to find the best parent student loan rates and compare across multiple lenders in minutes.
>> MORE: Best parent loans for college
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How Much Parents Should Save for College
While there is no “right” answer to how much parents should save for college, here are some general guidelines for how much you should have saved by the time your child enters college.
The ⅓ Rule
The ⅓ rule states that parents should be able to pay for their child’s college in thirds:
- ⅓ of the tuition should be paid by the parents’ income
- ⅓ should be paid by savings
- ⅓ should be paid for by grants, scholarships, and other sources of financial aid.
To calculate what ⅓ of tuition may cost when your child enters college, use a college cost projector calculator such as Vanguard’s. Then, divide the projected cost by 3 to find the amount you should aim to save.
For example, let’s say that your child was born in 2015. While you don’t know which school your child will attend, you know they will enroll in around 11 years. According to Vanguard, 4 years of college will cost around $167,266 total by that time. So, you’d want to aim to save $55,755.
>> MORE: What are the different types of financial aid options?
The 2k Rule
The 2k Rule expects that the cost of tuition will grow 3% above the national inflation rate in a four-year period and that parents will cover 50% of their child’s tuition with savings.
To calculate how much you will need to save to cover 50% of your child’s tuition with +3% to the national inflation rate every four years, take the following steps:
- Multiply your child’s current age by $2,000. (Ex. Your child is 16 years old. 16 x 2,000 is 32,000).
- Calculate how many years left until your child goes to college, and multiply that number by $2,000. (Ex. Your child is 16 years old and you expect them to go to college in one year. 1 x 2,000 is 2,000.)
- Add up the totals from steps one and two to determine roughly how much money you will need to save up to pay for 50% of your child’s tuition by the time they go to college. (32,000 + 2,000 is 34,000).
Fidelity’s college savings calculator can also do the math for you.
The Best Way to Save for Your Child’s College
As a parent, there are a variety of ways to save for your child’s college. Here are a few options to consider:
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529 Plans
A 529 Plan is a college savings plan that offers both federal and state benefits when you use the money for educational purposes. There are two types of 529 Plans: an educational savings plan and a prepaid tuition plan.
- Educational Savings Plan: Parents can contribute money to the educational savings plan and choose investment options.
- Prepaid Tuition Plan: Parents can pay tuition that is based on the current tuition in advance for a specific university/group of universities.
| Pros of the 529 Plan | Cons of the 529 Plan |
| Earnings and withdrawals are tax-free for educational expenses. | There will be penalties if the money is used for non-educational purposes. |
| Investments can grow up to $500,000 over the life of the account. | Limited investment options in comparison to other savings options. |
| When the owner of the 529 Plan is a custodial parent or the dependent student, the total value must be reported as a parent asset on the FAFSA. |
Mutual Funds
Mutual funds are a type of investment fund that allows you to diversify your stock holdings by buying different stock options instead of just one. Your investment portfolio is usually managed by financial advisors, to whom you give your money to. As a parent, this option is a great way to start saving for college.
| Pros of Mutual Funds | Cons of Mutual Funds |
| Money can be used on anything. | Earnings are subject to annual income tax. |
| No limits to investing. | Capital gains are subject to tax when sold. |
| Earnings made on mutual funds will be viewed on your child’s FAFSA, affecting financial aid eligibility. |
Custodial Accounts
Custodial accounts are brokerage accounts that you open for your child and transfer to them once they reach the age of 18, 21, or 25 years old. You can invest in stocks, mutual funds, and bonds with a custodial account.
| Pros of Custodial Accounts | Cons of Custodial Accounts |
| Money can be used on anything. | Your child may be subject to the kiddie tax when they receive the account. The tax is on any unearned income they receive that exceeds $2,300 when or before they are 23 years old. |
| No limits to investing. | The brokerage account will be viewed as your child’s financial assets on their FAFSA, affecting financial aid distribution. |
| The account’s value can be removed from your gross estate. |
Savings Bonds
Savings bonds are securities that are backed by the United States Government. They are incredibly safe investments with a 100% money-back guarantee, along with any interest that accrues.
| Pros of Savings Bonds | Cons of Savings Bonds |
| Federal tax-deferred and state tax-free. | $10,000 limit for individuals and $20,000 limit for joint couples annually. |
| Safe, guaranteed return on investment. | Lower returns compared to other investment options. |
Roth IRAs
Roth IRAs are individual retirement accounts that you can put after-tax money into and enjoy tax-free growth and withdrawals. Penalties can be waived if money is withdrawn and used for educational expenses.
| Pros of Roth IRAs | Cons of Roth IRAs |
| Offers a wide range of investment options. | Maximum annual contribution is $6,000 if you are under 50 years old. |
| Not counted as a parent asset on the FAFSA. | Educational withdrawals will count as untaxed income and reduce your child’s financial aid eligibility. |
| Only for individuals who earn less than $144,000 or joint individuals who earn less than $214,000 annually. |
Should Parents Save for Their Child’s College?
Saving for your child’s educational expenses comes with many benefits. For one, it will alleviate the thousands of dollars in debt that your child will have to pay off. If you start early, you will have the power of compound interest and time on your side, allowing you to save more with less. Plus, it is better to save money now rather than borrow later.
>> MORE: Best student loans for parents with bad credit
However, there are certain things that are far more financially beneficial for your family and should take precedence over a college fund, such as:
- An emergency fund: Every family needs a rainy day fund for any storms that life throws at you. Whether it is an unexpected medical emergency, a necessary home repair, or an out-of-the-blue expense, you’ll want to be prepared for whatever comes your way.
- Paying off high-interest debt: High-interest debt is notorious for growing exponentially, putting many families in more debt than they expected in a short amount of time. Before your debt becomes a larger problem than it has to be, paying off your high-interest debt should be at the forefront of your financial priorities.
- In some cases, a retirement fund: Retirement can be expensive. According to the World Population Review, you need at least $905,000 in your retirement savings to retire comfortably in 2022. It’s a difficult position to be in, but you’ll have to determine what costs more: the financial burden you may be on your children when you are retired versus the student debt your child will have to shoulder.
Saving for college costs should ultimately depend on your family’s financial situation. For some, it is more beneficial to save money now than to borrow later. For others, spending money to tie up loose ends is far more important than putting the money into a savings account.
>> MORE: Compare parent loan rates across different lenders
Closing Thoughts from the Nest
Saving for college as a parent can be a large concern. If your family is in the financial standing to save for college, remember to start saving early. Compound interest and time will be your two financial saviors in the face of college inflation.
Between the college fund options discussed above, be sure to thoroughly research each one to find what’s most suitable for you and your child.
Remember, not all families are in the position to start saving for college, and that is okay. Paying off high-interest debt, saving for your retirement, and adding to your emergency fund are all valid alternatives that will benefit your family in the long run.
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