If you are a parent, saving for your child’s education can be challenging, especially since you have to worry about your own retirement funds too. Today, I want to talk about some strategies for budgeting your child’s education. These are purely my own strategies and I have found them to be working so far. I will start with a lesser known option that I just discovered recently.
Option 1: The Series I Savings Bonds
This is a government-guaranteed investment and may not seem like the most thrilling idea. Why have you not heard of this before? That’s a good question. These savings bonds are not marketable, so they are not usually sold by brokerages. These bonds are backed by the U.S. government, and are sold directly by the Treasury through the TreasuryDirect site.
Let me give you a quick summary on these savings bonds:
- This savings bond earns interest based on combining a fixed rate and an inflation rate. The composite rate for I bonds issued from November 2021 through April 2022 is 7.12%. Yes, you read that correctly. The interest rate is 7.12%. From my research of savings bonds, this is actually pretty good. The website gives you a pretty detailed account of all the historical interest rates from 1998, so feel free to browse it. This rate has never gone below 7.12% before. Note, this 7.12% interest rate is more than double of the 2.23% yield on the U.S. Treasury bonds.
- The interest compounds semiannually.
- You can cash out the bond after 12 months. If you cash it out before the five years is up, you lose the last three months of interest.
- You may keep the bond for as long as 30 years.
- Investors can only buy up to $10,000 per person per year. So, if you have 4 persons in a household, you can purchase up to $40,000 per year.
- Minimum purchase is $25 if you are purchasing the electronic bond.
- The interest paid on these savings bonds is free from all state and local income taxes. For someone who resides in a high-tax area, this can be a very important feature!
- Interest is subject to federal estate and gift taxes as well as state estate or inheritance taxes.
- Note: if you use the money for higher education, it may keep you from paying federal income tax on your interest. Yes, read that again. If you plan to use the money for your children’s higher education, the education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon redemption of eligible savings bonds. However, your child needs to be 24 of older before that savings bonds can be issued tax-free.
Personal disclosure:
My husband and I each bought $10,000 of I Savings bonds last year in 2021 and we plan to buy another $10,000 each this year in 2022 as well. We plan on deferring the reporting of interest income until we file a federal income-tax return for the year in which we cash out the bond entirely. While we intend to use it on our kids for their college education, this plan is not set in stone since one of the criteria for taking the federal tax exemption is that your child has to be 24 years and older. Currently, I’d like to assume that my children will be done with college by then.
However, I’d like to stress that this is still a good way to invest your money, since these are inflation- protected savings bonds. Just to give you an idea, the Series I savings bond sales totaled to $2.78 billion in December 2021. A full year record had been $1.76 billion back in 2018. Many more Americans are piling into this inflation-protected savings bonds because of the recent inflation that we are experiencing in the U.S.
Option 2: Open a 529 college savings plan
I’m sure many of you have heard of this savings plan. A 529 savings plan is an investment account that provide tax-free growth and withdrawals for qualified education expenses.
Here is a quick summary on these savings plan:
- Each state has its own 529 program and its own financial firm to manage the funds. Therefore, fees can vary. Watch out for these fees because some 529 plans allow you to enroll directly, and some are offered through brokers. You want to make sure that these costs won’t pull too much from your earnings.
- You can choose any state plan that you want
- Tax benefits can vary by state. In some states, account holders get a small tax deduction on contributions, and some states offer a tax credit.
- Interest compounds
- Pay attention to the 529 contribution limits. According to the IRS, contributions cannot be more than the amount needed to provide for the student’s educational expenses.
- You don’t need to have a child to open one. You can open an account now, set yourself as initial beneficiary and switch the beneficiary to your child, or even your niece or nephew.
- You can change beneficiaries at any time
- Anyone can contribute to the 529 plans. For those practical family members, instead of buying expensive toys, 529 contributions can make a great birthday and holiday present.
Personal disclosure:
My husband and I started a 529 fund recently for our children and are contributing a fixed monthly amount into the account. We plan on using all the funds in this savings plan for their education when the time comes.
Option 3: Buy rental properties
While not everyone can do this, I would highly recommend this option if you have the means to buy rental properties. These rental properties can help pay for your child’s education in some ways, and the most obvious being the monthly income that you take in every month.
The second way it can help pay for your child’s education in the future is through real estate appreciation. Just imagine this scenario: you bought a property for $150,000 when your child was 5 years old. You took out a mortgage of $100,000. Assume your monthly rental income is enough to cover your mortgage payments. 15 years later, you are ready to enroll your child in college. Your mortgage balance may be around $50,000, but your property may have appreciated to $250,000. That leaves you with $200,000 in equity. Even if you deduct your initial capital of $50,000, you still net $150,000. You can sell the property and use the cash to pay for your child’s college education.
Some people say that rental properties are not really passive income. They definitely require some research, knowledge and time on how to buy and manage one, so you should do your own research.
Personal disclosure:
I bought a house about 7 years ago for about $200,000. I collected a rental income of about $1500 a month for the past 7 years which was enough to cover all my expenses plus the mortgage of this property. Now, my property is worth around $270,000. While I’m in no hurry to sell the property, I have certainly gained equity to help pay for some of my kids’ education fund.
Final words
If you do your own research, I’m sure that you will find many other ways to budget for your child’s education. They are definitely not limited to the 3 options mentioned above. No matter which option you decide to go with in the end, just note that educational tax deductions and credits can make a big difference in the long run. Take the time to do your research, and learn about the different benefits of each plan. I’m sure you will find the best strategy to save for your child’s education fund.
Disclaimer: I am not a certified financial adviser. Please do not take anything on here as financial advice. Do your own research before making any investment decision. The contents on this post are for your information only. I will not and cannot be held liable for any actions you take as a result of anything you read here.