There’s been a lot written recently about the cost of higher education and the growing
levels of student loan debt weighing down America’s young people.
This is a serious problem with a massive ripple effect on the financial health of the nation. [See: Why You’re Broke – The Student Loan Burden.]
Many pundits have thrown out possible solutions to the problem, ranging from adjustments to loan terms and more public investment in higher education. There’s also been a healthy discussion about which colleges and degree programs offer the best value to students.
But there is one part of the equation that too often gets ignored in the conversation: parents.
In my view, parents should play a significant role in helping save for their kids’ education. And they can help their kids out immensely with a relatively modest monthly investment, especially if they begin saving early.
Do you have $200 a month? Because that’s all that parents might require to send a child off to college debt-free.
The math behind it is simple. Begin when your child is born. Place $200 into a mutual fund that mirrors the S&P 500 or the total stock market. There are many investment options that do this. I like the Vanguard 500 Index (VFINX), the Fidelity Spartan 500 Index (FUSEX) or the iShares Total Market ETF (ITOT).
The average returns on these investments is about 9 percent annually. With a typical return, $200 a month will result in about $108,000 when your child turns 18. That may be enough for four years of college, or at least enough to avoid a huge student loan burden.
Open a 529
It’s important to note that its possible to save for college and get great tax breaks, too. Most states partner with financial institutions to offer a “529 plan” that allows investment returns to grow tax-free.
Usually, money is placed in a “targeted” fund designed for children of a specific age. Such funds have a more aggressive investment strategy early on, then gradually become more conservative as the child become closer to college age.
Money in 529 plans can be withdrawn tax-free if used for college expenses.
I have my sons’ college savings in 529 plans through state of Maryland, which has partnered with T. Rowe Price. In Maryland, you can pretty much contribute as much money as you want, and up to $2,500 per year can be deducted from your taxes. (This is in addition to the investment gains being tax-free.)
In addition to a 529 plan, it’s also possible to contribute to something called a Coverdell ESA. These accounts work similar to a retirement account. They allow you to invest in anything. You can only contribute $2,000 annually, but the money can be used for any education purpose, including private elementary and secondary schools. Not all brokerage firms offer ESA Coverdell accounts, but they are available through TD Ameritrade and Charles Schwab.
Don’t Be Shocked
The key to the strategy above is to give time for the investments to grow. You can’t end up with $100,000 if you start saving when your kid is 17. It is possible to open a 529 plan once your child has a Social Security card.