Strategizing College Savings: What You Need to Know
November 28, 2023
As we navigate through the end of 2023, many of us are reevaluating our financial strategies – particularly when it comes to saving for education. As both a financial advisor and a parent, I'm often asked about the best ways to save for college. Here are some common questions I hear, along with my recommendations.
What are the best ways to pay for college?
Broadly speaking, there are three ways to pay for college: (1) current income, (2) future income (i.e. student loans), and (3) past income (savings).
While the best approach for you depends on your unique situation, a balanced approach I often recommend follows the "1/3 Rule." In this approach, you aim to save 1/3 of college costs beforehand, pay another 1/3 from income during the college years, and cover the remaining 1/3 through scholarships, student income, or student loans if necessary.
When is the ideal time to start saving?
While it’s easy to be distracted by the looming specter of college costs, I strongly encourage parents to prioritize their retirement savings first –setting aside 10-15% of their income. Once that’s in place, saving for college is the next step.
If the budget doesn’t quite allow for college savings yet, that’s OK – your savings is not the only way to pay for college. For example, the Tennessee Promise Scholarship offers two years of tuition coverage at Tennessee community or technical colleges.
Where should I save for college?
529 plans, which are available in most states, are excellent vehicles for education savings. They offer tax-free growth and withdrawals for education expenses. As such, they should be the first place to consider saving for college. And while Tennessee's TNStars is an excellent choice, remember that you’re not limited to your state’s plan. (While federal tax benefits are the same for all 529 plans – tax-free growth and withdrawals for qualified education expenses – state tax benefits can vary. Some states offer tax deductions or credits for contributions to their own 529 plans.)
Each state sets a maximum contribution limit for its 529 plans, typically ranging from $300,000 to $500,000. This cap is the total amount you can contribute over the life of the plan. As for withdrawals, there's an annual limit of $10,000 for K-12 education expenses, and no annual withdrawal limits when it comes to college expenses.
How much should I contribute to a 529 plan?
For those looking to save about 1/3 of college costs for a child, a good target is $170 a month or roughly $2,000 per year. If you're able to save more, consider a regular brokerage account (outside of the 529 account) for the excess. It's important to balance your 529 contributions – over-funding can lead to penalties for non-educational withdrawals (if your child does not attend college, for instance, or receives a large scholarship).
If you have a lump sum available now to fund the 529, the right amount to add likely depends on whether you plan to use for K-12 and what college the child might attend.
Any additional tips for college savings?
For families with an adjusted gross income under $218,000 (married filing joint in 2023, $138,000 single), I recommend first maxing out any Roth IRA contributions ($6,500 per person) before contributing to a 529 plan. And consider Roth contributions in 401(k)s or 403(b)s if your tax bracket is below 32% ($364,000 joint, $182,000 single). IRAs and 401(k)s can be used for college expenses, but don’t have to – which means you can save any funds left over for retirement.
The college savings landscape is constantly shifting. For further questions, reach out to your financial advisor. And if you don’t have one, at CapWealth, we’d love to help. We take pride in our Sophisticated Simplicity® and Provable Integrity®, where our desire is to make complicated things simple and also to communicate to our clients with clarity and transparency.
