Paying for a College Education: Planning & Saving

by Doug Schmitt, Contributing Writer
Paying for a College Education: Planning & Saving

As the cost of higher education increases with each passing year, it becomes more and more difficult for families and individuals to have enough funding on hand to afford a college education. Paying for a higher education can seem like an insurmountable task. But with proper planning, meticulously selected savings and investment plans, and access to information regarding financial aid, college can be affordable for just about anyone.

Whether you're a parent starting a college savings fund for a newborn or helping a high school-aged child figure out how to make college affordable, or thinking about a career that requires you go back to school, there are numerous reasons why it's important to be informed about saving and paying for a higher education.

The Costs of Higher Education

When attempting to estimate how much going to college can cost, realize that there are two halves to that cost.

The first are direct costs. Direct costs are the primary costs to an education. They include basic tuition, room and board, and lab fees as well as various charges that different schools may assess.

The second are indirect costs. Indirect costs are charges that aren't applied by the schools themselves, but are unavoidable due to circumstance. Students and parents can control these costs to a significant degree. They include, but are not limited to, various personal expenses, transportation costs, and most importantly, book fees.

Once you have figured out the direct and indirect costs, you can efficiently approximate yearly college costs.

Plan Ahead

As most families use savings and financial aid along with current earnings to pay for college, there are some great reasons to start planning early:

  • The earlier you start planning, the smaller the monthly amount that you have to put away, making saving for college easier on the family budget.
  • Savings and investments can earn interest and grow ten-fold between the time a child is born and the time they graduate high school.
  • Money in savings or investment accounts generates additional money though compound interest.

Overall, planning means more savings, which means more schools from which to choose. As well, it means that your child can graduate college and begin a job search with fewer bills and more financial stability.

How Much Should Be Saved and How Do I Save?

So just how much money should be saved? Well, it's important to save as much as possible, even if the only amount you can afford to save is small. Set a savings goal, and break it down over months and years so that it's manageable. Try starting small, increasing the amount saved as you earn more money.

In addition to saving, the method of saving is an important angle to factor into the savings equation. There are several methods of saving for your child's education.

The most popular options are:

  • Savings Accounts: Depositing money in a bank is practically risk free and federally insured; however, the interest earned can be less than that of other savings plans.
  • 529 Investment Plans: Tax-free investments in many state 529 College Investment plans will save money. Several states limit the amount that can be invested, though interest earned may grow beyond the limitations. Money can only be withdrawn for educational expenses.
  • Roth IRAs: Contributions may be withdrawn without tax or penalty. Interest earned may be withdrawn, but will be taxed.
  • Coverdell Education Savings Account: This is similar to an IRA account, which is also used to save for college education. The tax-free annual contribution limit for a Coverdell ESA is $2,000. Money can only be withdrawn for educational expenses.
  • Mutual Funds: These accounts do not grow tax-free, nor do they allow money to be withdrawn tax-free. Money can be withdrawn for reasons other than educational expenses.
  • Prepaid Tuition: Prepaid tuition plans are state-funded plans that guarantee current tuition costs. amd enable you to prepay tuition. However, this plan is not available in all states. When the plan is available, it's limited to schools within the state only.

So where does a parent start? Patricia Konetzny, CFP, who runs the website The Practical Planner and is a member of the Cambridge Advisors, says that IRAs are an excellent starting point.

“I feel strongly that parents should save in their own Roth IRAs for college before they start specific college savings,” says Konetzny.

It's important to be aggressive with your savings when your child is young, and as they get older, move the “nest egg” to an account that has a lower risk.

“The maximum Roth contribution for 2006 is $4,000 unless the parent is over 50 (it's $5,000 then). Roths give them flexibility to take the money out for college or keep it for their own retirement,” says Konetzny. “They could save $8,000 together. Contributions to Roths can always be taken out. The interest will be taxable if used for education, but they won't have a 10% penalty.”

But What About Those Indirect Costs?

Personal expenses such as meals, pens, paper, and entertainment are a large part of college finances. What will your child live on? How will you get money to them when they need it? How do you budget that money?

One option that parents can use to help their child manage personal expenses and to budget is to open a checking account for them. When choosing a bank, it's important to make sure that the bank you choose has a branch as well as ATM machines near the campus and in your town.

As well, a prepaid debit card, such as a Visa Buxx card can be purchased for them. Parents can add money to it over the telephone or online. Along with being able to budget the money spent, parents receive monthly statements so they may monitor for what the money is being spent.

Be it a checking account, a prepaid debit card, or both, it's important to be sensible about budgeting. "Don't deposit the entire semester's money in your bank account in September," says Konetzny. Her daughter had run out of money by the end of November.

“I thought it would be a good learning experience for her to have to self-discipline for the entire semester,” says Konetzny. “But when she ran out of money, I told her what I would tell a client: you either have to make more money or spend less. It was too late to spend less for that semester, so she made plans to come home for the weekend, work, and earn enough money to get her through.”

More Information

For more information on federal and private loans, see FinAid.org and the Financial Aid channel on FastWeb.com.

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