If you’re a working parent, you know firsthand about the difficulties of finding quality, affordable care for your children. But eventually, your kids head off to school, and those child care bills go away, or at least diminish greatly. When that happens, you could start putting away money for another one of your children’s milestones: college.
Just how expensive is child care? Costs vary greatly among the 50 states, but the national average for a 4-year-old at a child care center is approximately $7,880 per year, according to Child Care Aware of America, a child care resource and referral agency sponsored by the U.S. Department of Health and Human Services. What could you do with this money once your child enters kindergarten?
Of course, not all schools provide all-day kindergarten, so you still may have some child care costs. For the purposes of illustration, let’s presume you can finally say “goodbye” to child care costs when your child is in first grade, and let’s also assume your child is attending a public school. If you invested that $7,880 every year for 12 years, until your child reaches 18, you could accumulate more than $150,000 in a tax-advantaged college savings account, such as a 529 plan — assuming the money was placed in a hypothetical investment that earned 7% per year. (Keep in mind, though, that the word “hypothetical” means exactly that, because whenever you put money in any variable investment, there are no guarantees.)
Actually, earnings in a 529 plan accumulate and are distributed tax free, provided they are used for qualified higher education expenses. (529 plan distributions not used for qualified expenses may be subject to federal and state income tax and a 10% IRS penalty on the earnings.) Also, your 529 plan contributions may be deductible from your state taxes. However, 529 plans vary, so be sure to check with your tax advisor regarding deductibility.
A 529 plan offers other benefits, too. For one thing, the lifetime contribution limits are generous; while these limits vary by state, some plans allow contributions well in excess of $200,000. And a 529 plan is flexible: If your child decides against college or vocational school, you can transfer the unused funds to another family member, tax and penalty free.
A 529 plan is a widely used choice for college savings, but it is not your only option. You could also consider a Coverdell Education Savings Account, which, like a 529 plan, can generate tax-free earnings if the money is used for higher education expenses. You can typically only put in a maximum of $2,000 per year to a Coverdell account, but it lets you use the funds on K-12 and college expenses.
Whichever college-savings vehicle you choose, it will take discipline on your part to continue investing in it, year after year. And after freeing yourself from those child care bills, you can certainly think of other ways to use this “found” money. That’s why you might want to automatically move money from your checking or savings account to your 529 plan, Coverdell account or other investment earmarked for college. As your income rises over the years, you can increase the amount of these automatic transfers.
In any case, once those child care bills stop, you can put that money to work on your children’s behalf. Make the most of this opportunity.
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