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The Best Way to Save for College

How to balance different savings goals and avoid mistakes when paying for college.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Morningstar director of personal finance and retirement planning Christine Benz has put together a monthly financial to-do list for 2022, and October's to-do is all about how to save for college.

Christine, thanks for being here. Good to see you.

Christine Benz: Good to see you, Susan.

Key Takeaways

  • Finding balance is key. It's important to balance college savings alongside other important financial goals, retirement savings being the main one.
  • If you go with your home state's 529 plan, you're typically able to earn a tax break on the contribution. 
  • Don't overcomplicate saving for college. Typically 529 plans offer age-based tracks, so you can select the plan that corresponds with your child's age, and those options are really hands-off. 
  • Overextending the parents' financial situation in an effort to pay for college is a big mistake that investors make. 

Dziubinski: One key challenge that many families face is, I have, you know, I want to send my kids to college. I want to save for college, but then I have these other goals like retirement. Any tips for how to think about balancing a variety of different goals when college is one of them.

Benz: Balance, is really the keyword. Like so many things in life, it's important to balance college savings alongside other important financial goals, retirement savings being the main one. You have to put retirement savings in the front seat, because if you come up short with your retirement savings, you just simply have fewer levers than you do with college. And another thing I would say on the college front, I think parents might be put off by these incredibly high numbers we see in the realm of what college costs today. I was looking at in-state tuition at public universities--$9,000, $19,000 for out-of-state students at those public universities. Some elite public universities are charging well more than that. And of course private-school tuition has gone through the roof, too, where it's like $38,000 I believe is the average, and many elite private institutions are charging upward of $60,000.

Don't be blinded by those really high numbers, recognize that for all but very, very wealthy families, college funding is probably going to come from a variety of sources. So, it might be your personal savings, that might be a component of it, but so might financial aid, so might loans, so might a healthy dose of compromise on the part of your student, and that might entail some work in college. When college comes close, you'll be able to look at the whole toolkit and recognize that for many households, aid, financial aid, merit-based aid will be a big piece of the puzzle. I would urge everyone to read Ron Lieber's great book on this topic. It's called The Price You Pay for College. Really great explainer of how merit-based aid works.

Dziubinski: And in your podcast The Long View you actually interviewed Ron about this very topic about a year ago.

Benz: We did, and he is a fount of wisdom on this topic of paying for college.

Dziubinski: Now there are already different vehicles or tools that parents or family can use to help save for college. What do you recommend? What do you think is the best tool for folks to use.

Benz: Well, I would say the basic, main receptacle that people should use is a 529 college savings plan. And there are a few key reasons to look at 529, the big one is tax breaks. So if you go with your home state's plan, you're typically able to earn a tax break on the contribution. As long as the money stays within the 529 plan, you're able to enjoy tax-deferred compounding on your money. And then when the money comes out to pay for college, assuming it's going for qualified college expenses, those withdrawals are also tax-free. You get some nice tax breaks for using a 529 plan. The other big advantage is that for super savers especially, you can get a lot of funds into a 529 plan and there aren't any income limits that would clamp down on how much you can put in there. So, some nice tax benefits and also just a lot of flexibility built in.

Dziubinski: How would an investor have a sense of what they should be looking for when they're choosing a 529 plan?

Benz: I would say the starting point is to look at your home state's 529 plan. But I would also urge people to take a look at our College Savings Center on Morningstar.com. We've got a map where you can dial in and look at your home state. See what sort of plan is on offer. Our team does these great annual ratings of 529 plans. I believe the next round of ratings is coming out in November. But it's a really nice distillation of how various plans stack up from the standpoint of investment options and fees. And I'm happy to say when we look at the data since we've been covering 529 plans and certainly other entities have been shining a light on this space as well. We've seen fees come down. We've seen investment lineups improve. It's, I think, a fact of life that transparency, shining a light in this space has really helped improve the plans.

Dziubinski: And let's talk a little bit about investing those 529 plan assets and the investment choices that you have within a 529 plan. What's your advice there?

Benz: My advice is to not overcomplicate this. So, typically 529 plans do offer age-based tracks so you can select the plan that sort of corresponds with your child's age. And the nice thing about that is that those options are really hands-off. So as your child gets closer to college, the plans will typically take risk off the table. And the nice thing is we've seen 529 plans, the age-based plans, really get religion about the importance of becoming more conservative as that matriculation date draws close. We saw some plans get into trouble during the great financial crisis, more plans have cleaned up their act. So, we're seeing more of these age-based plans really sort of being in sync in terms of being thoroughly derisked at the time that college is upon your child.

Dziubinski: Lastly Christine, what are some common mistakes that families make when they're saving for college? What are some things that they should try to avoid doing?

Benz: I think a big one is overextending the parents' financial situation in an effort to pay for college. I truly get it. I get where parents are coming from in terms of wanting to raid their own coffers to try to make college work. But generally speaking, if you're having to reach into your own Roth IRA or take a home equity loan or take what's called a Parent PLUS loan, which is basically a loan in your own name to pay for your child's education. Those are probably red flags that you are putting your own financial life at jeopardy. I think that's a big risk factor for parents.

Dziubinski: Well, Christine, thank you for your time today. It's a really overwhelming topic for parents.

Benz: You know.

Dziubinski: I know, having just sent our children to college.

Benz: Right.

Dziubinski: We really appreciate your time and your tips when it comes to this.

Benz:Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch "What Belongs on Your Preretirement Radar?" for more from Christine Benz. Watch "3 Recession-Resistant Stocks" for more from Susan Dziubinski.