How to save for your kids' college education

Saving for college does not have to mean anticipating every expense to ensure you've prepaid your child's higher education endeavors.

It just means doing what you can.

"There are some big numbers out there, so one of the first things we look at is not getting overwhelmed with the cost," said Chris Lynch, president of TIAA Tuition Financing Inc. "Creating good habits around savings is probably one of the most important things that people can do."

Setting aside the cultural and political conversation of who should pay for college and how much it should cost, family members who want to help pay for a child's education expenses face a number of decisions about how to best set aside money, not to mention how much.

Whether your child is age 1 or 17, experts agree it's never too late to start saving, as even $25 out of every paycheck can make a difference.

The hardest but most rewarding part is simply starting now. Because "saving" for college is better described as investing for college, and the longer money is in an investment, the better chance it has to grow in value.

"This is one thing that tends to get put on the back burner, but time is the biggest asset," said Mary Greener, a tuition financing consultant at TIAA. "The more time you have to save and ride the ups and downs of the market, the more chances of overall success you'll have."

First steps

Every family's situation is different, so the best savings approach will be different for every college-bound kid. But there are a few checklist items that are universal.

"Let's first talk about what you're doing to save for your financial future, then how does saving for college fit in," said Autumn Schinka, a Cottage Grove-based financial adviser with Thrivent. "What we don't want people to do is sacrifice their own retirement plans to help with college. Then they get to retirement and have to depend on their children."

Dealing with high-interest debt, like credit cards, should be a priority. So too should emergency reserves, retirement savings and a solid understanding of how much money is coming in and where it is going.

Then comes college savings.

For those not intending to cover all college costs, a general guideline is to save a third of expected costs, have student loans cover a third and have scholarships, financial aid and/or current income cover the rest.

"That's a very rough rule of thumb," Lynch said. "But it gets back to what I was saying: I don't want people to get so overwhelmed looking at the total cost of higher education they stop saving."

The best way to ensure money makes it to the savings account is to "set it and forget it."

"Automating that savings is key," Schinka said. "I have lots of clients just putting $50 a month into a college savings account, and that adds up over time."

Unless your student plans to use that money in the next few months, though, don't put it in a normal savings account.

What's a 529?

A 529 plan, named for Section 529 of the federal tax code, is an investment account with tax benefits that encourage saving and spending for higher education. It also allows spending on K-12 expenses and student loan repayment.

Each state offers at least one 529 plan. In the North Star state, it's the Minnesota College Savings Plan. But savers can open an account from any state.

Plans are similar to retirement accounts. You can automatically move money from high-earning (and riskier) stocks into less-risky investments as they near a target date, in this case, the first year of college.

Withdrawals for qualified education expenses — which include tuition, room and board, books and technology — are tax free. Minnesota also offers a state tax deduction or credit for those contributing to 529 plans.

The downside is withdrawals for any other reason are subject to a 10% penalty as well as a tax on investment gains. And because it is an investment account, it might lose money; though Minnesota offers an investment option that guarantees what you contribute will remain available to withdraw in the future.

If a child changes college plans or receives more scholarships than expected, leftover money in a 529 account can roll over without penalty into a Roth IRA starting in 2024.

For financial aid purposes, many recommend parents, guardians or other family members be the account holders for 529 plans rather than the student. But you only need one account per student, as family and even friends or neighbors can make gifts to the account. Plans can change beneficiaries if needed, including to a parent wanting to go back to school or pay student loans (up to $10,000 per beneficiary).

As of March, there were more than 91,000 Minnesota Savings Plan accounts open, with an average balance of about $20,000, according to the College Savings Plans Network.

Not all college savings will or should end up in a 529, however.

"There doesn't have to be just one approach," Schinka said. "It can be a combination of things."

Other alternatives

While 529 plans are built specifically for higher education, other types of investments can accomplish the same goals with different pros and cons.

Coverdell ESA

A Coverdell education savings account (ESA) is similar to a 529 but has a $2,000 annual contribution limit per child and is only available for couples making less than $220,000 a year or individuals earning less than $110,000 a year. As with a 529, there is a 10% penalty for nonqualified withdrawals. Unlike a 529, which never expires, you must use the money by the beneficiary's 30th birthday, in most cases. It can be more self-directed than many 529s.

Roth and traditional IRAs

You can also use pre-tax (traditional) and after-tax (Roth) individual retirement accounts to pay for qualified education expenses without penalty. This could, however, affect financial aid and/or retirement planning.

Brokerage account

To invest on your own and avoid the limitations — and benefits — of a 529, simply open a brokerage account and put money in stocks, bonds, mutual funds or other financial instruments. Keep in mind there might be capital gains taxes to pay, and there are implications for financial aid when it comes to a family's expected contribution. Alternatively, 529 account holders often have the option of having more say in where to invest their money as opposed to managed accounts.

Uniform Gifts or Transfers to Minors Act

Commonly known as UGMA and UTMA, these custodial accounts can hold different types of assets but are irrevocable, meaning contributions belong only to the beneficiary when they turn 18, and that person can only use the funds for a specific purpose.

Cut the check

On July 10, Lynch made a tuition payment for his child at the University of North Carolina out of a 529 account.

"They work," he said later that day.

He knows more than most. As president of TIAA Tuition Financing, he oversees 1.6 million accounts in seven states, including Minnesota's 529 plan. While most accounts don't come close to covering the full cost of four years of tuition — not to mention housing, books, transportation and other expenses — on average there is a "meaningful amount of money people have saved." And any total will help your future student, as the cost of tuition alone just for an in-state resident to attend the public University of Minnesota is nearly $17,000 a year.

"If people start small, over time, they will increase contributions," Lynch said.

While surveys show a majority of parents have little or no savings set aside for college, that can change in 20 minutes with $25.

During a webinar for the Minnesota College Savings Plan on Tuesday, TIAA consultant Greener said "the toughest part is sitting down and opening an account."

"The best thing I can encourage is to do it."