Thinking of saving for your child’s college fund? Follow the 10-50 rule of thumb.
Save 10 percent of your paycheck per child. If circumstances prevent you from saving 10 percent, save at least $50 per month per child.
The 10-50 rule allows you to reach what financial advisors calculate as a healthy balance to pay for your child’s college expense. This calculated balance is based on another rule of thumb: the one-third rule.
One-third of a child’s college expense comes from your savings. Another third comes from current income while the rest comes from student loans.
The key is deciding where to invest savings following the 10-50 rule of thumb. Two choices: 529 plan or Roth IRA.
A 529 plan is a college savings plan that allows you, as the parent, to invest in mutual funds on behalf of your child. A Roth IRA is an investment account that allows you to save money for your retirement or your child’s college expense.
• If you are certain that your child (or at least one of your children) will go to college, invest in a 529 plan. Earnings on 529 investments are tax-free as long as these are used for educational purposes. If these are used for other purposes, it is subject to tax and a 10 percent penalty. (Remember, though, that a 529 plan is transferable to another child.)
• If you are uncertain that your child will go to college, try investing in a Roth IRA. Roth IRA investments are tax-free and can be used however you want, as long as these are withdrawn when you are at least 59 and a half years old and the account existed for at least 5 years. If not, taxes and a possible 10 percent penalty apply.
• Some college scholarships and grants disqualify students who have a 529 plan. 529 investments are considered assets of your child, not yours. Roth IRA investments are considered your assets, not your child’s.
• Investing in Roth IRA for your child’s college expense uses up one of the few tax-free retirement savings options available to you.
Note: The above are general guidelines and only applicable to the United States. It is always wise to consult with a financial advisor in determining the best plan for you and your child.