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Financial Aid

Introduction to Saving for College

Mark Kantrowitz

August 19, 2009

Introduction to Saving for College
You're about to have a baby and you're already worrying about how to pay for their college education. Or your son or daughter just started high school and you read about some private colleges costing more than $50,000 a year. How are you going to be able to afford four years of a college education?

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Don't panic! The solution is to start saving for a college education as soon as possible. The sooner you start, the easier it will be, and the more flexibility your child will have in their college choices.

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Top Ten Practical College Savings Tips

The following practical tips present everything you need to know about

how to get started:

1. Set Reasonable Goals.

You don't have to save the full cost of college. Like any other big expense, you pay for college over time. One third of college costs will come from past income in the form of savings, one third will come from current income and financial aid, and one third from future income in the form of loans. Since college costs increase by a factor of three over any 17 year period, a good rule of thumb is to base your savings goal on the cost of college the year your child was born.

Don't get sticker shock from the high cost of the most expensive colleges. The average cost of a 4-year private college is about half the maximum cost and the average cost of a 4-year public college is about a quarter of the maximum cost. (The overall average is about a third.)

Use FinAid's Savings Plan Designer to translate your savings goal into a monthly contribution. For example, if you save $250 a month at 5% average interest from birth, you will accumulate $80,465 by the time your child enrolls in college. FinAid also offers several other savings calculators that you will find useful.

2. Start Saving Sooner, Rather than Later.

Time is your greatest asset. The sooner you start to save, the more time there will be for your savings to grow. For example, if you start saving from birth at 5% average interest, 37% of your savings goal will come from interest. If you wait until your child enters high school to start saving, only 10% of the savings goal will come from interest.

3. Make Saving Automatic.

Set up an automatic transfer from your checking account to your college savings plan. This makes it much easier to save.

4. Save Whatever You Can.

Get started saving, even if all you can save is $10 or $25 a month. Saving something is better than saving nothing. It is much easier to increase the amount you save after you get started. Take one step at a time. Increase the amount you save when you get a raise. Most families end up saving $100 to $250 a month, but every penny helps. Calculate your college savings, college cost and education loans with our calculators.

5. Save a Portion of Windfalls.

If you get an income tax refund, bonus or inheritance, or win the lottery, contribute some of the money to your children's college savings plans. When your child no longer needs diapers or day care, redirect that money to the college savings plan. You won't miss this money because you were already spending it.

6. Save as Much as You Can.

It is cheaper to save than to borrow. Saving $250 a month at 6.8% interest for 10 years will yield a total of $43,041. Borrowing the same amount at 6.8% interest with a 10-year repayment term would require payments of $495 a month, almost twice as much. When you save, you get the interest, but when you borrow, you pay the interest.

7. Save with a 529 College Savings Plan.

Section 529 College Savings Plans provide a tax-advantaged way of saving for college, similar in concept to a 401(k) or IRA. The earnings in a 529 plan are tax deferred, and distributions are tax free if used to pay for qualified higher eduation expenses. The parent, as the account owner, controls the 529 plan account, not the child. The money in a 529 college savings plan will have a minimal impact on your child's eligibility for need-based financial aid.

Consider your state's 529 plan if your state offers a state income tax deduction for contributions to the state's plan. Also consider the 529 plans in the states that have the lowest fees (less than 1%). These include plans by Vanguard and TIAA-CREF.

Use direct sold plans, not advisor sold plans, as the advisor sold plans add on commissions and fees that can wipe out the tax savings. The advisor may steer you toward plans that maximize his commissions and which aren't in your best interest. You don't need an advisor to tell you how to invest, as you don't need to make many choices.

8. Use an Age-Based Asset Allocation.

An age-based asset allocation fund starts off with an aggressive mix of investments (e.g., mostly stocks) and gradually switches to a more conservative mix of investments (e.g., mostly bonds, CDs and money market accounts) as college approaches. When your child is about to enroll in college, no more than 20% of the college savings should be in stocks. While it may be tempting to invest everything in an all-stock fund because of the higher returns on investment, keep in mind that the stock market will drop significantly at least once a decade. When your child is young, you have a lot of time to recover from losses (and the dollar amount of the losses will be small). But when college is around the corner, you need to protect more of the savings from dramatic losses. Two-thirds of families use an age-based asset allocation.

9. It is Never Too Late to Start Saving for College.

Even if college is just a year or two away, the short-term tax benefits can be worthwhile. Some state 529 college savings plans offer a deduction or tax credit on your state income taxes, which is like getting a discount on college costs. Every dollar you save is a dollar less you'll need to borrow.

10. Maximize Your Savings with a Rebate Program.

There are several college savings rebate programs like Upromise that let you earn rebates from your purchases that are automatically contributed into your college savings plan. Even if you don't change your purchasing habits you can still earn hundreds or even thousands of dollars of rebates that will help your college savings grow.

Additional Resources

The following resources on the FinAid site are helpful:

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