My Virtual Log Book

We all know that a college education is important, but did you know that, according to U.S. Census Bureau statistics, people with a bachelor’s degree earn nearly twice as much on average than those with only a high school diploma?

The challenge is that the cost of a college education continues to rise considerably faster than inflation. Four-year private college prices increased 5.9 percent from last year and four-year public colleges increased 6.3 percent from last year. If these increases continue, in 18 years, a college education is expected to cost over $145,000 for Public colleges and over $325,000 for Private colleges.
How to Save?
There are a number of possible ways you could start saving for a college education but the two most popular tax advantaged options are the 529 and Coverdell plans.

529 - A 529 plan is a state sponsored, tax advantaged savings plan. While the specifics of the plans vary by state, they generally allow for the education savings to grow federal and state tax free. 529 plans generally have high contribution limits and can be used for a variety of educational expenses in addition to tuition such as housing or books. While the plans are state sponsored they are almost always run by large financial institutions and the investment choices are sometimes limited to a specific set of investment choices offered by the state. For example, the California “ScholarShare” College Savings Plan, is managed by Fidelity Investments and offers a maximum of 24 different investment options. The “ScholarShare” College Savings Plan allows contributions up to $60,000 ($120,000 per married couple) per beneficiary in a single year.
Shop around for the best state plan - you are not limited investing in your state of residence. Be sure to investigate the amount of “load” or management fees that are charged by the financial institutions for each state plan. High fees can significantly reduce your college nest egg.
Coverdell Savings Account - A Coverdell Education Savings Account (formerly an Educational IRA) offers many of the same tax advantages of a 529 plan with some important differences. A few of the differences include: a significantly lower contribution limit ($2,000 per year per child) and significantly greater flexibility of type of investment vehicles (e.g. stocks, bonds, mutual funds, etc..)
When should I start saving?
Staring down that big future tuition number can be daunting but the most powerful effect you can take advantage of is the power of compounding.  The two factors that affect compounding are time and rate of return. Start saving as soon as possible and find an investment vehicle that maximizes your return for a reasonable amount of risk. A $10,000 investment in U.S. Government Bonds today will be worth $24,700 in 20 years. Not a bad return and certainly a low risk choice but the return pales in comparison to higher return alternatives.

If the same money was instead invested in a broad market index mutual fund and if that fund returns something close to the long term historical average for equity indexes then that $10,000 would be worth over $46,000. Of course, investing in mutual funds is more risky than government bonds, and there are no guarantees, but a long term investment horizon can help mitigate any short term market fluctuations.

In summary, there are many good tax-deferred ways to save for your child’s education and you should start saving as soon as you can – even a little can go a long way with compounding. There are also a number of resources on the web to check out such as:

• collegesavings.org - Good information on 529 plans including what types of plans are available by state
• savingforcollege.com- Good general overviews of college saving information
• collegeboard.com – The SAT guys and a great source of statistical information

Filed under: Finance