MintFamily with Beth Kobliner: How Do I Start Saving for My Child’s College Education?

I recently heard from a reader who asked about the best way to save for his sons’ college educations. He’s starting early: One son is 5, and the other is due this month.

Now that’s planning in advance! (But don’t worry if your kids are older—as long as they’re not going to college tomorrow, there’s still time.)

This dad is looking for a low-risk investment that lets him start with a relatively small amount. Here’s my advice for him, and other parents in a similar boat.

Don’t shoot the messenger.

I have to start with some scary news: The sticker price of public four-year colleges has more than tripled since the early ’80s, even adjusting for inflation. Total outstanding school loans in America recently topped $1 trillion, more than the nation owes on credit cards! And this summer, the interest rate on federal loans will double to 6.8%, unless Congress votes otherwise.

Meanwhile, college is getting more and more important. Last year, college grads earned twice as much and were half as likely to be unemployed as those with only a high school diploma.

It’s OK to be selfish—really!

The first step to saving for your children’s future? Max out your own retirement savings so your kids won’t have to lend you money when you’re older. And if they have to take out modest federal loans to pay for college, it’s not the end of the world. They have the rest of their lives to pay off that debt.

Know when you can afford to be generous.

If you’ve maxed out your retirement plans, and you’re not carrying lots of high-interest credit card debt, only then should you consider saving for your kids’ educations. Start by looking into 529 investment plans, state-sponsored educational savings plans that offer tax advantages similar to those of 401(k)s and IRAs. Investment minimums are nonexistent or very low, sometimes just $25 a month.

Each state’s 529 plan is a little different, and you don’t have to invest in your home state’s version. You can find a lot more information about 529s at www.savingforcollege.com.

One thing to know about 529 plans is that they include strict limits on what you can invest in and where you’re allowed to spend the money. If your kids secure full scholarships, or if they choose super-affordable schools, or skip college altogether, you can transfer the money to another family member for his or her education.

But otherwise, you might have to close the account, and pay taxes and a penalty on your investment. Meanwhile, some critics have questioned the security of prepaid 529s at a time when many states’ finances are in shambles.

So while these plans are a great deal for many families, proceed with caution, as you would with any other investment.

I Bond, you bond, we all bond!

A 529 plan is not your only option. If you’re starting small, consider a type of savings bond called an I Bond, issued by the U.S. Treasury. Unlike traditional savings bonds, I Bonds have built-in protection against inflation. They currently offer a 2.20% interest rate—more than double what most bank savings accounts offer, and still better than the rates on a 5-year CD. You can get started with as little as $25, or buy as much as $10,000 per year.

But remember, you can’t touch that money for a year, and if you take it out before five years, you’ll lose the last three months’ worth of interest. For more information and to purchase an I Bond, visit www.treasurydirect.gov.

For a smart look at long- and short-term strategies for paying for school, check out Kal Chany’s book “Paying for College Without Going Broke.”

There’s always old-fashioned savings.

So, dear Dad, none of this rules out taking your sons down to the local bank branch or credit union and opening up a traditional savings account in which they can sock away birthday money and allowances. Savings accounts have rock-bottom interest rates right now, but at least your money will be FDIC-insured up to $250,000.

More than that, opening a savings account with a kid is a great investment in his financial literacy.

Have you started saving for your kids’ college educations? What strategies are working for you?

© 2012 Beth Kobliner, All Rights Reserved

Beth Kobliner is a personal finance commentator and journalist, the author of the New York Times bestseller “Get a Financial Life: Personal Finance in Your Twenties and Thirties,” and a member of the President’s Advisory Council on Financial Capability. Visit her at bethkobliner.com, follow her on Twitter, and like her on Facebook.

Source: mint.intuit.com