how to use compound interest to save for tuition

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  • Student loans are a $1.4 trillion crisis in the United States
  • It is the second largest consumer debt after mortgages in this country.

Meghan Finnerty, a former colleague, has often spoken of how her social life suffered from having to pay $908 a month to pay off student debt. She lives with her parents in Spencerport to save money and has to budget for going out.

A 2017 graduate of Arizona State University, Finnerty owes about $80,000 in student loans, which she will repay over 10 years. She works as a multimedia producer at the College of Brockport.

Like many recent college graduates, Finnerty struggles with an albatross in the form of student loans. The crisis is so severe that it prompted a discussion on Capitol Hill in the House Financial Services Committee this month.

Nationwide student loans now total over $1.6 trillion, with over 44.7 million borrowers. It is the second largest category of consumer debt in the country after home mortgages. Tuition, room and board at private universities could now cost more than $70,000 a year.

For those with young children, there is a glimmer of hope. Time is on your side. Thanks to the power of compound interest, it is possible to ease the financial burden when it comes time to pay for your child’s higher education.

Start early with a plan

Compound interest is one of the most important concepts to understand when it comes to personal finance. This is how to earn interest on your initial deposit. and earn interest on the interest you just earned.

Compound interest is interest earned on money that was previously received — “interest on interest”. This concept is a powerful tool when saving for education and retirement goals, said Nannette Nocon, private wealth investor at Nocon & Associates in Rochester.

The earlier the savings start, the more interest is compounded. Compound interest works on fixed investments such as money markets, savings accounts, and CDs as well as college savings (a 529 plan).

If a family put aside $100 a month in a 529, that family could accumulate a significant sum in 17 years. The value depends on how much risk the account holder is willing to take, Nocon explained. Many 529 platforms have age-based portfolios that reduce stock holdings as the student approaches college. Assuming a conservative rate of return of 6%, the estimated total of $100 per month over 17 years would be $35,887.

To maximize a 529 plan, Nocon recommends financing in the amount of $10,000 for maximum New York State tax savings. Account holders who are New York taxpayers can deduct up to $5,000 of contributions from their income taxes each year; $10,000 if you are married and filing jointly.

Investment earnings grow tax-free when used for eligible educational expenses. Note “subject” because the 529 plans are specific to education spending.

It can be difficult to determine when your child will be 18 months old if they will go to higher education. We started from the moment our daughter was born with the idea that she would have to continue her training somewhere, whether it was a four-year college or other training grounds.

Another thing to note about the 529 plan: For tax purposes, contributions are considered gifts. The gift tax limit for 2019 is $15,000 per person. If you donate more than $15,000, the excess will be deducted from your lifetime estate and your gift tax exemption, Nocon said.

Was it worth it?

Some may think Finnerty is an extreme example of student debt, but it’s not uncommon to come out of a four-year private school now with $80,000 in loans. Such a large payment will seriously affect a youngster’s career decisions. I know I couldn’t have afforded the tough early years of journalism if I had had large student loans.

I asked Finnerty if she regretted taking the loans and might have been happier at a cheaper school.

“I always say I’ll tell you if I regret it in 10 years“, she said. “Because this is the education I wanted, and if it gets me where I need to be professionally, it could very well be worth it.”

Throughout her time in college, she told herself that she was investing in herself.

“So it’s up to me to make this expense worth something. But it stinks. I think about my loans all the time. Heck, even my friends think about my loans,” Finnerty said.

Finnerty spent a year at community college to save money and worked throughout college as well as applying for scholarships.

“Yet that’s what I have left. Every month, my minimum payment is $908,” she said sadly. “And I’m getting out of it little by little.”

After: Tuition Sticker Shock: How to Afford It or Make a Better Choice

Mary Chao is the retail and real estate reporter for the Democrat and Chronicle. His passion is helping families save time and money. Email [email protected] with tips and ideas.

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