Deciding Whether and When to Start Saving

If you're like many new parents, you find it a challenge just to pay for your baby's current needs, much less worry about saving for college and other educational expenses. Fortunately, there is no rule that everyone has to begin a college savings fund as soon as a child is born; it all depends on the particular situation. Depending on your circumstances, it might make sense to start immediately, or it might be smarter to put off education savings in favor of other needs, such as buying a home. This section will help you decide whether and when your family should begin saving for your child's education.

My child hasn't even started walking yet; isn't a bit early to start thinking about saving for my child's education?
No. You should start thinking about saving for your child's education as early as possible, even before your child starts kindergarten.

Why should I start saving early?
A lot of reasons. First, because college tuition costs generally grow at about double the rate of inflation, if not more. The only way to keep up with these spiraling costs is to save early and to save often.

Second, you'll have to save much less in the long run because your investment earnings will compound the value of your money. In other words, your money will work harder for you with every passing year because you will earn money not only on your original investment but also on that investment's appreciation. Thanks to the compounding power of money and the tax breaks built into some of the education savings plans discussed in the following chapters, even a little bit of money saved each month can take a big bite out of your child's future education bills.

EXAMPLE 1: You start saving just $50 each month on the day your child is born, using a tax-advantageous Coverdell education savings account. By the time your child is ready to go to college, you will have saved nearly $20,000 (assuming an average investment return of 6%). What's more, you won't owe even a dime in capital gains taxes on the earnings so long as you use them to pay for your child's college tuition.

EXAMPLE 2: The year his child was born, Alvin invested $10,000 in a bond fund that grew by 5% each subsequent year. Alvin did not add any more money to the account in the years that followed. In the first year, Alvin earned $500 on his investment. In the second year, Alvin earned $525 on his investment even though the fund's growth rate did not change. Alvin's profits increased because he earned a 5% rate of return on his original $10,000 investment, as well as on the $500 of profits from the year before ($10,500 x 5% = $525).

Third, you won't have to worry about the ups and downs of the economy. Having a long investment horizon will allow you to benefit from good economies and survive the financial storms of bad economies without stress or worry.

Finally, setting aside a small sum of money for your child's education on a regular basis is infinitely easier on the family budget than facing a giant bill down the road.

Now that we have a new baby, money is extremely tight. Do we really need to begin saving for our child's education right now?
Not necessarily. Although saving early is a good idea (see above), it isn't the best idea for all families. In fact, financial experts say that you shouldn't even think about saving for your child's education until your family is in good financial health overall. Priorities that are more important than education savings include:

• Paying off high interest debt. Nothing can get in the way of your family's financial future like credit card and other high interest debt. Before creating an education savings account for your new baby, pay off all debt with an interest rate of 10% or higher.
• Building an emergency fund. Every family needs a small stash of cash to cover unexpected expenses. Having a financial safety net in place will ensure that your family can comfortably weather life's ups and downs.
• Making sure that you are fully insured. Part and parcel of getting your financial house in order is purchasing adequate life, health, and disability insurance coverage to ensure that your family will be provided for regardless of what lies ahead. (You can learn more about health insurance in Chapter 15 and life insurance in Chapter 37.)
• Saving for retirement. You might be surprised to learn that experts recommend that you fully fund all available pretax retirement accounts—such as a 401(k) or IRA—before putting away a single dollar for your child's education. Why? Although it may not be ideal for your child to rely on financial aid or scholarships to foot college tuition bills, it would be far worse for your child to be burdened with the obligation to support you throughout your retirement—or, worse yet, for you to be stuck in dire financial straits in the event your child doesn't have the resources to help you. After all, your child can take out loans to help pay for education; you cannot do the same to help pay for retirement.
• Time with your family. If saving for your child's education means you have to work extra-long hours, forgo family vacations, or otherwise sacrifice the quality of life with your family, don't do it—or at least, do it to a lesser degree.

We are saving for a down payment on our first home. Is it okay to postpone saving for our child's education?
Absolutely. Thanks to the mortgage interest deduction and the investment potential of real estate, buying a home is one of the best financial moves your family can make. Some experts even recommend that you buy a home and pay down your mortgage before you begin contributing to an education savings plan for your child. This is because you can always take out a home equity loan down the line—and deduct the interest on that loan for tax purposes—if you decide to use the money you've invested in your home to pay for your child's education expenses.

We are so cash strapped that it feels like we don't have enough money to save for both retirement and our child's education. Do you have any advice for saving for both at the same time?
A Roth IRA is one of the best ways to save for retirement while keeping open the option of paying for your child's college education. A Roth IRA is a savings account that allows your retirement investments to grow entirely tax free. What's terrific about a Roth IRA is that you can withdraw the funds in your Roth IRA to pay for your child's higher education expenses without paying any penalties. You will, however, owe capital gains taxes on the earnings unless you happen to be 59½ or older by the time your child is ready for school. To learn more about Roth IRAs, check out the discussion in Chapter 26.

A Short-Term Mortgage Can Help Pay for College

If you qualify, can swing the extra payments each month, and plan to own your home for a long time, consider getting a 15-year mortgage rather than a longer term loan. You'll pay less interest and build equity faster, so that your home will be paid off by the time your child goes to college. Take, for example, a $300,000 fixed-rate loan at 6%. Here's how much your monthly and total payments would be for a 15-year and 30-year mortgage:

Term of Mortgage	Monthly Payment	Total Paid
30 years	$600	$215,838
15 years	$844	$151,894

In this case, you'd pay $244 per month more with a 15-year mortgage, but nearly $64,000 less in interest than a 30-year term. If you bought your house when your child was a baby, you would be through with house payments by the time college rolled around! While this example is admittedly simplistic, it highlights the savings available in short-term mortgages. To run the numbers yourself, check an online mortgage calculator, such as the one found in the Real Estate section of "Property and Money" at www.nolo.com, or talk to your banker.

If you don't want to commit to high monthly payments, you can achieve similar savings by voluntarily paying more principal each month on a longer term loan. This gives you more flexibility—you don't legally obligate yourself to the higher payment each month, so you can change your mind and pay less if need be.

There's no way I will be able to save enough to pay for my child's college education in full. Can't I just rely on financial aid or scholarships to cover my child's future education costs?
Unfortunately, no. The main sources of financial aid and scholarships are the federal government and the schools themselves—and both take the position that parents have the primary responsibility for paying for their children's education. If your child does manage to qualify for some form of financial aid, chances are that it will be in the form of loans, not grants or scholarships. This means that the less you can contribute to your child's education bills, the more your child will owe in student loan bills after graduation.

Moreover, most financial aid and scholarship programs don't cover all of the expenses associated with higher education. For example, the average federal Pell Grant covers only 23% of the costs of attending a four-year state college. Unless you have savings that you can tap into, you and your family may have a very difficult time making up the shortfall in college expenses.

Won't I hurt my child's chances of qualifying for financial aid by setting up an education savings fund?
Parents often worry that a dollar saved in a child's education fund will be a dollar lost in future financial aid. Fortunately, it usually doesn't work that way. Unless you invest your money in a 529 prepaid college tuition plan or a custodial account for your child (more on both of these in Chapter 26), the financial aid impact of a college savings fund will be minimal for most families.