According to the Student Loan Marketing Association, American families spent around US$26,226 for their kid’s education in 2018-19. Around 79 percent of the parents in the study were willing to stretch themselves financially in order to fund the education of their children.
Helping out with college
“Few of today’s students can go to school full time, study enough hours to be academically successful and work enough hours — for enough income — to pay their own way… College costs have climbed faster than wages, and working part-time simply doesn’t provide enough income to pay for tuition, fees, and living expenses,” Marjorie Savage, author of You’re on Your Own (But I’m Here if You Need Me): Mentoring Your Child During the College Years, said to Nitro.
The bottom line is that your kids probably won’t be able to afford college unless they take on a huge amount of debt. Unfortunately, this debt can trap them for a big part of their lives, with most of their youth spent on repaying the loans. As a parent, you might feel that it is your duty to help out. However, you will also have to fund your retirement. So how much should you actually help with your children’s college expenses?
As a rule of thumb, your retirement savings should be 25 times your current annual spending. So if you currently spend US$60,000 per year, your portfolio should be about US$1.5 million at the start of your retirement. By withdrawing 4 percent per year, adjusted for inflation, you should be able to live out your life with the savings. As such, any amount in excess of saving toward such a target can be invested in your kid’s education.
For instance, if you have 30 years until retirement, you need to save around US$1,800 per month to reach the goal of a US$1.5 million retirement fund assuming a 5 percent annual interest rate. If you have US$2,400 in your account every month after meeting all your expenses, you should be able to allocate up to US$600 per month for your child’s college fund. If you just save around US$400 per month in a plan that gives you a 5 percent annual return, you can gift your child with an education fund of US$60,000 in 10 years.
How to save
A great way to save is through a 529 plan. “529 plans are named after Section 529 of the Internal Revenue Code (IRC), which was added in 1996 to authorize tax-free status for ‘qualified tuition programs.’ Earnings in 529 plans accumulate on a tax-deferred basis and distributions are not taxed federally when used for qualified higher education expenses. The definition of qualified higher education expenses was expanded in 2015 to include computers and in 2017 to include up to [US]$10,000 annually in K-12 tuition,” according to Saving for College.
529 plans have higher contribution rates, which can go up to US$300,000 in some states. There are usually no income limits. However, some restrictions will be applicable if you wish to transfer the 529 plan to another child. An Education IRA allows you to save up to US$2,000 per year per child. You might earn a higher rate of return through an Education IRA than traditional savings. Plus, it is tax-free. However, the contribution limit of US$2,000 per annum could be a problem if you want to save more.