Saving for Your Child's Education

When our children are still but a bundle in our arms it can be difficult to imagine that the day will come when they will go off to college. But even if your mind has trouble wrapping itself around this reality, your checkbook certainly shouldn't.

With the burgeoning costs of tuition in the United States and around the world, it's no surprise many parents are starting their savings plans early. But just how early should parents begin putting money aside? And for that matter, how much? We have composed a guide to help you understand the reality of education costs and what you can do to be prepared for the big day.

The Costs of a College Education

A recent report issued by Congress stated that college costs in the United States have reached critical highs. Beating out the rising costs of inflation, family incomes and even financial aid, tuition fees are slowly forcing young people out of the college market.

Currently, students are paying about $20,000 a year for private universities, with an average annual inflation of about 6%. That means that if these trends continue, by the time your baby turns 18 you'll be looking at a whopping total of $230,000 for a four-year college education. But don't let those numbers scare you into financial hiding. Fortunately, most students attend public universities and pay a fraction of the price.

In fact, some 70% of students pay less than $8,000 a year for their education. And only 7% attend schools with tuitions of more than $24,000. No matter where your child decides to attend college, however, it's never too early to start saving. In fact, the earlier you start, the less you have to put in every month.

For example, even if you're only able to put aside $25 a month, at a 10% interest rate you'll still be looking at $13,000 by the time your baby turns 18. Combine that with student loans and your child's own savings (not to mention possible scholarships), and he should be well on his way to a brighter future. Of course, here is where the tricky part comes in. With so many different types of savings plans out there, how do you know which one will give you the best bang for your buck?

The Different Types of Savings Plans

Which plan you choose will depend on several factors. First you must decide how much of the total cost of tuition are you planning on covering. Some parents want to be able to pay 100% of their child's tuition, while others feel their children should also pay a share of the costs. Whatever your opinions on the issue, be sure you think about this before you decide on a plan. The percentage you choose will influence how much you will need to pay on a monthly (weekly, quarterly or yearly) basis. Here are a few of the more popular types of savings plans out there:

The 529 College Savings Plan

One of the more popular types of education savings plan is the 529 plan. The primary advantage of this type of plan is that withdrawals are tax-free; as long as they're used for education. The only drawback to this is that your child must go to college, or else you could stand to lose a lot of money. Another benefit of the plan is that is allows you to start small (as little as $25); and, because the money in the account is considered to be an asset of the parent and not the student, it will not be weighed heavily against them should they require supplementary financial aid.

Prepaid Tuition Plans

These savings plans allow you to actually pay for your child's education (that means a complete four year degree) now, at today's prices. So while that $10,000 a year tuition fee might seem like a lot now, imagines how you'll feel once it reaches more than double that amount. The advantage to this type of plan is that, if you have the money now, you can save tens of thousands of dollars virtually risk-free. People with more modest budgets can simply pay a percentage of the expenses. The potential disadvantage to this type of plan is that because they are administered by the state, your child is required to attend a college or university in that state.

Coverdell Education Savings Account (ESA)

This type of account works in a very similar way to an IRA, except that it's used for education and not retirement. The account provides for a maximum annual contribution of $2,000 per student. The earnings grow tax-free as long as any withdrawals are used for education related costs. However, unlike the prepaid tuition plan, the Coverdell ESA is not exclusively limited to the tuition itself: it can also be used for costs associated with attending an elementary or secondary school (including uniforms, computers and transportation) as well as room and board. The type of investment is chosen by the person in control of the account and may include stocks, bonds or mutual funds. The funds must be used by the time the beneficiary turns 30 years old.