Seeing the price of college education can cause sticker shock for a lot of parents. It can be hard to know where to start, especially when you have more immediate financial priorities, like childcare, housing and car payments.
Having a plan and investing early is critical to ensuring you (or your child) won't be buried in student loan debt down the line.
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$5,000 minimum (or up to state); maximum up to cost of attendance
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When should you start saving for college?
The most important part of saving for college is investing as early as possible. Since compound interest is earned on both the initial investment and the interest you've accumulated, your gains will be much larger if you start investing at birth.
You can think about it like this: With compound interest, an initial investment of $1,000 will yield earnings of $100 after one year if there's a 10% interest rate that's compounded annually. Your second year, you'll earn an additional $110 because you'll be receiving 10% interest on the $1,100 you've accumulated.
How much should you be saving for college?
Including tuition, room and board, books and supplies, an in-state public college cost close to $30,000 for the 2024-2025 academic year, according to The College Board, while an out-of-state public college cost close to $50,000. For a private college, the price tag was approximately $63,000.
Generally, the price of college increases by a factor of 3 roughly every 17 years. How much of your child's college education you want to (or can) pay for depends on many factors. Mark Kantrowitz, author of How to Appeal for More College Financial Aid, recommends the one-third rule: One-third of the cost of a four-year college education comes from your income and financial aid, one-third from savings and investments and one-third from student loans.
T. Rowe Price, however, suggests aiming to cover 50% of the cost of college by reaching a certain benchmark at each birthday.
| Age | % of one year of college saved |
|---|---|
| 1 | 15% |
| 2 | 25% |
| 3 | 40% |
| 4 | 50% |
| 5 | 60% |
| 6 | 70% |
| 7 | 80% |
| 8 | 90% |
| 9 | 100% |
| 10 | 110% |
| 11 | 120% |
| 12 | 130% |
| 13 | 135% |
| 14 | 145% |
| 15 | 155% |
| 16 | 160% |
| 17 | 170% |
| 18 | 175% |
Source: T. Rowe Price
If you can't put a lot away right now, you can always ramp up your monthly contributions over time.
It's essential, though, to start early to take advantage of compound interest.
Where should you invest your money for college?
Consider opening a 529 savings plan, a state-sponsored investment account used for investing in educational expenses. With 529 savings plans, individuals can use the money they withdraw for college and K-12 tuition and other qualified educational expenses without paying income tax on any investment gains.
And since January 2024, however, unused funds from a 529 plan can be rolled over into a Roth IRA account tax-free, turning it into a retirement account.
529 plans contain a variety of different funds such as mutual funds, bonds, funds and ETFs. They are generally recommended for investing for college because of the tax benefits people get from them: You can contribute up to $15,000 tax-free (for single tax-filers) and your earnings will grow tax-free.
States offer different 529 savings plans, and you don't need to be a resident of that state in order to qualify for an account. However, certain states may offer tax benefits for in-state contributions. For example, in New York, in-state residents have tax-deductible contributions, so residents can reduce the amount of their taxable income if they invest in a 529 savings plan.
You can also opt to invest for your child's education using a brokerage account or a 529 prepaid tuition plan.
If you opt for a 529 prepaid tuition plan, you pay for tuition at certain colleges at today's rate. By doing so, you're hedging against inflation and rising tuition costs. While you can transfer your funds if your child chooses to attend a different college, prepaid tuition plans have their drawbacks: there are only 18 state-sponsored plans that offer this, you have to be an in-state resident and they don't cover additional educational expenses like 529 savings plans do.
You might also consider investing your money in a brokerage account through companies like E*TRADE or Vanguard. If you go this route, however, you'll have to pay taxes when you sell any funds or stocks that have grown in value.
Saving for college FAQs
How much do I need to save for my child's college education?
A common rule of thumb is to try to save for a third of the total cost of a child's college education, including tuition, room and board, textbooks and other fees. The other two-thirds can be covered by financial aid, student loans, grants and other sources.
T. Rowe Price recommends having saved approximately 60% of the cost of one year of school by the time your child is 5 years old, 90% by the time they are 8 and 130% when they hit 12. This is just a rough guideline, however, and the actual amount you'll need will depend on the type of college (public vs. private), location (in-state vs. out-of-state), scholarships and other factors.
What is a 529 savings plan?
A 529 plan is a state-sponsored education savings account designed to encourage parents to invest in their child's future by allowing earnings to grow tax-free. Withdrawals from a 529 are tax-free as long as they're used for qualified educational expenses. Since January 2024, unused funds from a 529 plan can be rolled over into a Roth IRA account tax-free, in essence turning it into a retirement account.
What is a pre-paid tuition plan?
Some state universities allow you to pay for future credit hours over many years, potentially saving thousands over what it would cost to pay when your child enrolled. While this can give your family peace of mind, it assumes your child is not only attending college but a state school.
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