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Many parents would say saving for their children’s college education is pretty high on their list of priorities, and yet they don’t have a savings plan in place.
That’s understandable. Saving is becoming more of a challenge these days, especially when you consider the forces working against parents. College tuition and fees keep rising, students are spending more than four years in undergraduate programs, and postgraduate and/or professional education is becoming a requirement for many employment opportunities.
Also working against parents: The increase in the cost of college tuition, known as the college inflation rate, averages around 5% per year. This means a college with a $20,000 tuition will cost you $21,000 next year. If you have a 10-year-old child, then that same college might cost you more than $30,000 by the time your child graduates from high school.
With younger children, you have time on your side — time to create a savings plan, time to save consistently and systematically, time to meet (or beat) your savings goal. And as your income rises over the years, you can contribute more toward college savings.
But there are steps you can take to save no matter how much time you have. Here are three popular options to pay for your child’s education:
One of the best investment vehicles for college savings is the state-sponsored 529 plan, which lets parents set aside money in an investment fund for higher education. This is an especially good plan if you start early enough to reap the tax advantages: Savings in this type of plan grow federal-tax-free, and withdrawals also are tax-free as long as they’re used to pay for qualified education expenses. (Most states provide the same tax advantages for residents.)
Each state that offers a 529 plan establishes how the plan is structured and which investment options are offered, so make sure you know what’s available.
Another great feature: Grandparents can contribute directly to a 529 account on behalf of a grandchild, which can be an effective estate-planning technique if done correctly. For 2016, that means each grandparent can contribute up to $14,000 on behalf of a grandchild without triggering a gift tax or a generation-skipping transfer tax.
If your children are older and nearing college, savings options are fewer, unfortunately. But there’s still hope. You might have time to save a little and design a plan that incorporates scholarships, other awards and/or student loans.
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When you’re considering financial aid, be aware of the different loan options out there. Federal loans — Stafford, Perkins, PLUS — are available based on financial need and require the filing of a Free Application for Federal Student Aid, or FAFSA.
Private loans from banks or other financial institutions also are available to families to help pay for college; however, they tend to have higher interest rates than federal or state loans do, and they are not government-funded or government-guaranteed. Visit the Federal Student Aid website for additional information.
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Another option to consider is using your individual retirement account to fund college costs. If you use funds from your traditional IRA, you won’t pay the early withdrawal penalties, but you’ll still have to pay income tax on the amount distributed for qualified education expenses.
If you have a Roth IRA, you won’t pay a penalty or income tax on withdrawals used for qualified education expenses. One thing to keep in mind, though, is that Roth IRAs have income restrictions, so high earners might not qualify. And remember: The reason you’ve been saving in your IRA is to fund your retirement, so you might not want to spend all of that money on your kids’ educations.
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