Create a savings strategy for the child’s college

Create a savings strategy for the child’s college

As we navigate the end of 2023, many of us are reevaluating our financial strategies – especially when it comes to saving for education. As a financial advisor and a parent, I am often asked about the best ways to save for college. Here are some common questions I hear, along with my recommendations.

What is the best way to pay for college?

In general, there are three ways to pay for college: current income, future income (student loans), and past income (savings).

While the best approach for you depends on your unique situation, a balanced approach I always recommend follows the “1/3 Rule.” In this way, you aim to save 1/3 of the college expenses before, pay 1/3 from the income during the college years, and cover the remaining 1/3 through scholarships, income of student, or student loan if needed.

When is a good time to start saving?

While it’s easy to get distracted by the looming specter of college costs, I strongly encourage parents to prioritize their retirement savings by setting aside 10-15% of their income. Once that is in place, saving for college is the next step.

If the budget isn’t enough for college savings, that’s OK — your savings aren’t the only way to pay for college. For example, the Tennessee Promise Scholarship offers two years of tuition coverage at Tennessee community or technical colleges.

More: From a tax break on diapers to a property tax limit in TN: Financial bills to watch for in 2024

Where can I save for college?

529 plans, available in most states, are excellent vehicles for education savings. They offer free growth and withdrawals for educational expenses. As such, they should be the first place to consider saving for college. And while TNStars in Tennessee is an excellent choice, remember that you’re not limited to your state’s plan. (While the federal tax benefits are the same for all 529 plans — tax-free growth and withdrawals for qualified education expenses — state tax benefits can vary. Some states offer tax deductions or credits for contributions to their own 529 plans.)

Each state sets a maximum contribution limit for its 529 plans, usually from $300,000 to $500,000. This cap is the total amount you can contribute over the life of the plan. Regarding withdrawals, there is an annual limit of $10,000 for K-12 education expenses, and no annual withdrawal limits when it comes to college expenses.

How much should I contribute to a 529 plan?

For those looking to save about 1/3 of college costs for a child, a good target is $170 a month or roughly $2,000 per year. If you can save more, consider a regular brokerage account (other than a 529 account) for the extra. It’s important to balance your 529 contributions – overfunding can lead to penalties for non-educational withdrawals (if your child doesn’t go to college, for example, or receives a big scholarship.)

If you have a lump sum available now to fund a 529, the right amount to add probably depends on whether you plan to use it for K-12 and what college the child will attend.

Any more tips for saving for college?

For families with adjusted gross income under $218,000 (married filing in 2023, $138,000 single), I recommend first maxing out any Roth IRA contributions ($6,500 per person) before contributing in a 529 plan. And consider Roth contributions to 401(k) or 403(b)s if your tax bracket is below 32% ($364,000 joint, $182,000 single). IRAs and 401(k)s can be used for college expenses, but don’t have to, which means you can save any funds left over for retirement.

While saving for college isn’t easy, it can be done. And it usually starts with understanding your options and a simple plan. I hope these tips are helpful and wish you the best on your college savings journey. For more questions, contact your financial advisor. And if you don’t, at CapWealth, we want to help.

Hunter Yarbrough, CPA, CFP, is a vice president and financial advisor at CapWealth. He is passionate about taking a holistic view of personal finance, including investments, taxes, retirement, education, estate planning, and insurance. For more information about Hunter and CapWealth, visit capwealthgroup.com.

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