I am lucky enough to be a newly expecting parent this coming year. My wife and I are thrilled about the joy a baby will bring to us (and the challenges too, of course). We’re less than two months away from the anticipated birth of our child, and it feels like its going to be here any minute now the way time is flying by!
This past summer once we found out we were finally expecting, my first thought was, “wow, a baby is going to be expensive…how are we going to afford this?” We’ve been avid savers and budgeters for some time now so I had to figure out how I’m now fitting two more huge expenses in my month budget; diapers and college savings.
Like most new parents, the thought of college comes to mind fairly quickly, despite it truly being 18+ years away! But I know I want to address the issues ASAP versus delaying our savings plan. My parents did not save any money for me for college. They took on the brunt of student loans (and are still paying on them to this day).
I actually feel like they are miserable because of it too. My parents were never really open about college when I first began applying 15+ years ago. We didn’t really discuss anything about who was paying. I just applied, got accepted and they took control of the rest. Turns out I paid for most of my tuition and they paid for my room and board, as well as some other expenses.
I vow not to do this with my kid when this time rolls around. I was naive and had no idea just how much college cost and who was paying for it. My parents and I never really had those discussions. So here I am now trying to figure out how I can set money aside early and often to hopefully pay for as much college as possible for my soon-to-be child.
What is the best way to save for college?
529 College Savings Plan
529 plans are tax-advantaged savings vehicles that let you save money for the college expenses of a named beneficiary, such as a child or grandchild.
529 Contribution Limits
One of the primary benefits of 529 plans is its large contribution limits. Each state operates its own 529 plan and makes its own rules for the plan, so maximum contribution levels vary across plans. Generally speaking, contribution limits are high enough that most investors will never have to worry about hitting the ceiling.
Coverdell Education Savings Account
A Coverdell ESA is a tax-advantaged savings vehicle that lets you save money for the qualified education expenses of a named beneficiary, such as a child or grandchild. Qualified education expenses include college expenses and certain elementary and secondary school expenses.
ESA Contribution Limits
The annual contribution limit for Coverdell ESAs is $2,000 per beneficiary until age 18.
529 Plan vs Coverdell ESA
After doing my research on the two college saving vehicles, I lean much more heavily on the 529 plan. My main reason for choosing the 529 plan is because it has significantly more potential for future savings. If you maxed out an ESA account, which is $2,000/annually or $166/month, and earned an annual return of 7% annually, your savings would reach $67,726 after 18 years. That is still a nice chunk of change for college.
However, don’t you think during that 18 year span you can challenge yourself to save more than $167/month? Maybe not in the first few yeas but certainly shortly after you can find a way to scrape together $200-300 each month for your child’s college fund. With the same assumptions as above (7% annual return), your investment could be worth $122,396 after 18 years if you managed to save $300/month. That makes expensive college look a lot more affordable.