Question: My son is 7 (will be 8 soon) and I need to start saving for his college -- fast. I know I should have started sooner but here we are now with fewer than 10 years to go. What are some avenues to saving for college and get a good return? We'll want to be able to use the funds for any college or university, so we're probably not interested in state savings plans. How much should we save each month? We're not sure if he'll attend a public or private institution, but we want to have enough to get him through at least 4 years. DoVeanna, Tuscaloosa, AL
Answer: You're not too late. But first, I want to take a step back. It's smart to save for your child's college education. Savings will limit how much you and your child will have to borrow for college. Nevertheless, for many families I would put college education savings down on the list of your priorities.
Here's why: In a money-is-tight world, most of us need to focus on paying ourselves first, siphoning off money into savings for everything from an emergency fund to your retirement portfolio. It's underappreciated, but you can always draw on those savings to defray the cost of college.
The way I like to think about college savings is that its simply part of the automatic savings program you've established over the years. It's a simple strategy that gives you a lot of flexibility.
Now, let's say you're fine on the savings front and you'd like to target additional sums toward college. I think a tax-advantaged 529 college savings plan is a terrific choice. The after-tax money you contribute grows tax-deferred from both federal and state taxes, and when you withdraw the accumulated savings, it's free of federal taxes so long as it goes toward qualified educational expenses.
By the way, all 50 states offer 529s and you can invest in any of them. You aren't limited to your state. You live in Alabama, but if you liked California's 529 plan, you could open an account in the Golden State. The savings are available to be spent on any accredited public and private college in any state.
The big difficulty with 529s these days is that the option has expanded to offer a dizzying array of choices. I think the creators of these plans have forgotten that the accounts were supposed to make it simple and easy to save for college -- not to turn parents into Wall Street financiers comfortable with modern portfolio theory and the efficient frontier. Choosing a 529 takes research to find the right one for you. A good place to go to learn more and do research is savingforcollege.com.
I'll briefly touch on two other options. One is the Coverdell Education Savings Accounts. It allows for an annual (non-deductible) contribution of as much as $2,000 a year for your child. Again, the money can be withdrawn tax-free if it goes toward qualified educational expenses. Since many major investment firms offer Coverdells, a big advantage is the wide range of investment choices for those comfortable managing their own money.
Last, but far from least, is Series EE Savings Bonds and I-bonds. Yes, you will earn hardly any interest on them right now. But there's no credit risk, no cost to buy and sell, and the interest is free of taxes if it goes toward college (depending on your income). Savings bonds are a boon to small savers.
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