I can count on two hands and all of my toes (and beyond) the number of people who sat in my office and said, “I wish I’d saved more for college.”
I spent 12 years in college admission, and during this time, I heard hundreds of situations — families who had regularly saved money for college, people who hadn’t saved a penny, families who had sporadically saved over the years.
I heard, “We’re set!” to, “We were worried about the bills. We always said we’d eventually put money away for college but never did. Stuff just kept coming up — a new kitchen, a few vacations to Disney, and now, the kids are ready to go off to college. We haven’t saved a dime.”
(Don’t feel guilty if the second example sounds like you!)
Here’s the basic secret I discovered among the people who were successful at saving for college and education planning: They’d saved a little bit and invested it every month. That cumulative effect meant that they felt comfortable paying for college. They didn’t have a master’s degree in college financial planning. They automated everything.
- What is Automated Investing for Education Planning?
- How to Get Started Automating College Savings
- Step 1: Choose an investment type.
- 529 Plans
- Custodial Accounts
- Coverdell ESAs
- Stocks or Mutual Funds
- Roth IRAs
- Step 2: Set up automatic contributions.
- Step 3: Monitor your success.
- Automate Now to Benefit Later
What is Automated Investing for Education Planning?
Automated investing is just that — you set up your child’s college savings account so money goes directly into it each month. In other words, you put your money and your savings on autopilot. It’s one of the easiest ways to save for college.
You’ve heard of this method — it’s often called the “pay yourself first” method of investing. It’s extremely effective because you learn to expect the payment (which you can set for a particular day of the month). It becomes a normal part of your monthly expenses, 12 times a year.
How to Get Started Automating College Savings
During my years in admission, I noticed that one of the hardest things for parents to do was to just get started investing for college.
Families would relay to me, “I just wasn’t sure what to do. We didn’t start at all because we didn’t know where to put our money.”
Totally understandable! Here are three simple steps to get going.
Step 1: Choose an investment type.
You can find a dizzying array of college savings plans, investment types and companies that tout that they have “better savings options” and “fewer fees” than the competition. It’s great to do your own research, but when push comes to shove, it’s best to just make a decision so you’re actually doing it. You can always move your money later!
Let’s take a look at a few popular college savings plan options.
529 plans are college savings plans sponsored by a state or state agency. You can use these accounts, which grow tax-free, to pay for tuition, books and other qualified expenses. Your state often offers tax benefits for a large number of account types. When you take the money out of your 529 plan to pay for college, you won’t pay taxes as long as you use the money for qualified expenses, like tuition, room, board and school-related fees. (If you buy a car with the money, you’ll face a tax bite.)
Through a savings account at a financial institution or brokerage firm, you can invest money in a custodial account, a type of account set up for adults to invest for minors. Custodial accounts have longer, fancier names: the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). The state in which you live determines whether you invest in a UGMA or UTMA. The state also determines the age in which your child can take out the money — usually 18, 21 or 25. Custodial accounts offer tax advantages and have no income or contribution limits or withdrawal penalties.
The drawback to a custodial account is that your child can take the money out and spend it however he or she wishes. That means your child can use the money to buy a car or take an expensive trip.
A Coverdell ESA is a tax-deferred trust that you can open at a brokerage or other financial institution. It helps families by offering tax-free earnings growth and tax-free withdrawals on qualified educational expenses.
However, you do face some caps: You can only make annual contributions up to $2,000 for joint filers with a modified adjusted gross income (MAGI) up to $190,000. The options are reduced for a MAGI between $190,000 and $220,000. You cannot contribute to a Coverdell ESA if your income rises above $220,000.
Stocks or Mutual Funds
You may bypass “specified” college savings accounts and invest directly in stocks or mutual funds. Stocks represent an ownership share of a company. One stock represents one share of a company.
Mutual funds, on the other hand, refer to many investors who pool their money together to invest in bundles of securities. Mutual funds offer a more diversified investment than stocks, which offer more risk individually. Rather than putting all your eggs in one basket, mutual funds allow you to spread the risk around.
The downside to investing in stocks or mutual funds is that they don’t offer tax incentives strictly for education.
You may recognize a Roth IRA as a retirement vehicle — just as its name indicates. (IRA stands for “individual retirement account.”) However, you can withdraw from a Roth IRA in order to pay for qualified educational expenses tax-free.
The downsides: If you’ve had the Roth IRA for less than five years and you withdraw not just the principal amount contributed but also the earnings to pay for college, you’ll owe taxes on those earnings. In addition, pulling money from your retirement account means that you could inadvertently penalize yourself by neglecting your own retirement savings.
In order to contribute to a Roth IRA, your MAGI must be less than $129,000 if you’re single. If you’re married and filing jointly, you cannot go over $204,000. You can contribute a maximum of $6,000 to a Roth IRA if you’re younger than age 50. If you’re 50 or older, you can contribute an extra $1,000 per year in “catch-up” contributions.
I get it: Choosing an investment type is easier said than done. However, remember that taking some action is better than doing nothing at all.
Step 2: Set up automatic contributions.
Similar to direct deposit from your paycheck to your bank, you want to make sure money automatically goes from your bank to your investment account.
You can swiftly set up automatic withdrawals through your brokerage account, your state’s 529 plan site or other type of financial account. Choose a dollar amount to go into your account every month. Next, set up the automated deposits based on your paydays or a monthly contribution schedule. For example, you may choose to contribute $500 every month to your child’s 529 plan on the 15th of every month — or another day you get paid.
Some employers offer payroll direct deposit into a 529 plan account. Find out if your state’s 529 plan allows this.
Step 3: Monitor your success.
One of the best parts of automating your college savings involves watching it grow. You may want to change your action plan based on a college savings calculator, such as the college savings calculator from Fidelity. A college savings calculator can help you determine whether you’re on the right path.
Why not start out with a college savings calculator in the first place? Well, to be honest, it’s best to get started with a monthly amount you can afford rather than giving you the heebie-jeebies about how much college might cost in 18 years or less.
It’s best to save as much as you can, as often as you can. Your child may have to get student loans, and that’s okay. Right now, feel content that you’re doing as much as you possibly can.
Automate Now to Benefit Later
One more not-so-secret secret: Many plans will let you contribute as little as $25 per month. If you can afford $25 worth of candles at Target (I’m totally guilty!) you might be able to kick $25 toward your child’s college education.
In my experience, it’s about building up the confidence to invest and realizing that yes, you can do it. It just takes a little investigation on your part. Once you get going, setting up automatic investments and celebrating your wins becomes second nature.
If you’re thinking, “No way can I decide alone! I need help with this stuff,” you’re not alone.
Consider getting the advice of a local financial advisor. A fiduciary financial advisor (one who puts your best interests at heart) can also help you make your savings automatic. Trust me, you’ll feel great about taking this next step.