How to Save for College When Your Kid’s Still in Diapers

college savings plan

The cost of raising a child has reportedly never been as expensive as it is today. Raising a child born in 2013 to age 18 can cost more than $245,000, according to estimates by the U.S. Department of Agriculture.  That includes expenses such as education, healthcare, food and housing.

In today’s competitive economic landscape, kids need to be prepared to pursue higher education. In fact, college is arguably more important today than ever.

The average college graduate earns more than $800,000 more than the average high school graduate by retirement, according to the Federal Reserve Bank of San Francisco.

Because education is one of the biggest expenses to raising a child, it is important to implement a college savings plan early.

Keep Reading: Planning for Retirement Is No. 1 Money Challenge of Gen Xers

How Much Does It Cost to Raise a Child?

Child care expenses can be astronomical even for middle-class parents. The website What to Expect lists some of the costs of a child’s first year, including:

  • At least $150 per item for nursery furniture such as a crib, mattress, changing table and glider chair
  • At least $600 for disposable diapers
  • $1,500 or more for formula
  • About $560 or more a month for day care
Make Your Money Work for You

Those costs don’t stop after one year. Instead, new costs just keep piling on, from the cost for school supplies — which average more than $600 per family each year, according to the National Retail Federation — to the sky-high cost of car insurance for teen drivers.

Given all these costs, it is little wonder that many parents are exhausted by the very idea of saving for a child’s college education. But it doesn’t have to be this way.

Creating a College Savings Plan

In fact, saving for college doesn’t have to be hard. If parents can save just $100 per month for a child for college starting the first year the child is born and ending at age 18, the parents reasonably can expect to have enough to spend $20,000 annually on school for each of the next four years.

The chart below shows that if the stock market maintains the average rate of return of 11 percent, your college savings can grow about $60,000 by the time your child is age 18.

Related: 10 Things No One Tells You About The Cost of College

Make Your Money Work for You

Even after paying $20,000 each year for the next four years, a little more than $2,000 still remains in the fund. Of course, sometimes stock returns are higher, and sometimes they are lower. But over any given 18-year time frame, 11 percent is probably a reasonable approximation of expected returns.

That’s well within what most students need for college. According to the College Board, the average cost of tuition and fees for in-state public colleges for the 2014-2015 year is $9,131.

Tuition and fees for out-of-state residents cost an average of $22,958, while private schools averaged $31,231. Even after taking into account inflation in college tuition costs over time, parents can still save enough to give kids a great education without having to take on the burden of student loans.

Age Annual Cash Savings College Nest Egg Total
1 $1,200.00 $1,332.00
2 $1,200.00 $2,810.52
3 $1,200.00 $4,451.68
4 $1,200.00 $6,273.36
5 $1,200.00 $8,295.43
6 $1,200.00 $10,539.93
7 $1,200.00 $13,031.32
8 $1,200.00 $15,796.77
9 $1,200.00 $18,866.41
10 $1,200.00 $22,273.72
11 $1,200.00 $26,055.82
12 $1,200.00 $30,253.97
13 $1,200.00 $34,913.90
14 $1,200.00 $40,086.43
15 $1,200.00 $45,827.94
16 $1,200.00 $52,201.01
17 $1,200.00 $59,275.12
18 $1,200.00 $47,127.39
19 $1,200.00 $33,643.40
20 $1,200.00 $18,676.17
21 $1,200.00 $2,062.55

The Value of 529 Plans and Starting Early

The first key to saving for a child’s college fund is to start early. Even $100 a month saved toward college each month can be enough.

If that seems like a lot, it’s worth remembering that a 529 college savings plan can let you save for college on a tax-advantaged basis. These plans let you withdraw funds that are free from federal income taxes when they are used for qualified education expenses.

Make Your Money Work for You

Coverdell Education Savings Accounts work similarly. For many middle-class people, that $100 a month needed to fund college savings is just a little more than the after-tax cost of a cable TV subscription, which averaged just over $66 a month in 2014, according to the Federal Communications Commission. So for many parents, saving for college can be as simple as cutting the cord and switching to a low-cost streaming service for TV.

Tax Advantages of Having a Child

In addition, parents should make sure to take full advantage of the tax benefits of having a child. For 2015, the Internal Revenue Service is offering a $1,000 credit  to all parents of new babies. That credit directly reduces taxes, as opposed to a deduction, which just lowers your taxable income. That $1,000 alone essentially covers the savings needed for the first year of your child’s college education fund.

In addition, you can get a second credit toward taxes worth between $600 and $2,100 if you pay for child care. That credit varies depending on how many children the parents have, and how much the parents pay for child care. But unlike the new-baby credit, the child care credit is available every year that child care is needed. Again, this credit covers a major portion of what is needed for a college education for a child.

Make Your Money Work for You

In addition to tax credit benefits, parents can also benefit from claiming a child as a dependent. For 2015, a dependent provides you with a $4,000 deduction on your taxes. At a 25 percent rate, that equals $1,000 — again, just about enough to cover the investment needed for a reasonable college savings plan.

Single parents also can file as “head of household” rather than “single.” This moves the standard deduction for income from $6,300 to $9,250 in 2015. That $3,000 difference is worth about $750 at a typical 25 percent income tax rate.

The benefits are even greater if you adopt a child. Adoption can be very expensive, so parents adopting a child can get up to $13,400 in tax credits, and even more than that if the child in question has special needs. These adoption benefits phase out at high income levels, but for many parents, it’s worth having a conversation with a tax professional.

Related: Who Gets to Claim the Kids When Filing Taxes?

Start Saving Now No Matter How Small the Amount

While the cost of raising a child can be expensive, it doesn’t have to be a crushing burden for parents who are smart about saving money. From freebies to tax savings, there are plenty of ways for new parents to sock away a little extra cash.

Rather than spend that extra savings, just putting a little of that cash away every month through a tax-deferred plan will lead to significant college savings that can help a child get started as an adult with a college degree.

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About the Author

Michael McDonald

Michael McDonald is an assistant finance professor and consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance and his research has been quoted in the Wall Street Journal and Bloomberg. He provides corporate consulting through Connecticut Expert Witness Consulting and teaches classes in the areas of corporate finance and investments.

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