Avoid Common College Savings Pitfalls for Single-Income Families

Reyna Gobel
U.S.News & World Report LP

Laura Outlaw opened a 529 plan, a tax-advantaged college investment account, for her daughter almost 10 years ago, following her divorce.

Her daughter is now 19, but the Idaho single mother still makes automatic deposits. She wants to make sure her daughter has money for graduate school.

Having payments automatically deposited every month guarantees she won't be tempted to use the money for anything else. For her, the deposit into her daughter's college savings plan account is equivalent in priority to a mortgage, rent or utility bill: a static and required expense.

Setting up automatic payments works for Outlaw, but experts also offer the following suggestions for single-income families looking to make the most of their college savings.

[Understand what to do before opening a 529 plan account.]

1. Don't avoid risk: Often one-income families want to avoid risk altogether by stashing money in saving accounts, says David Bendix, a New York-based certified public accountant and personal financial specialist. But earning less than 1 percent interest in a savings account, rather than investing in mutual funds within a 529 plan, means families run the risk of not being able to afford college.

Instead of keeping money in a savings account, he recommends parents consider the amount of time kids have before college and invest appropriately. For instance, a parent should have more money in stock market-based investments for a 6-year-old child than a high schooler.

The alternative for one-income families who want to limit the risk of low growth as well as hedge against a potential drop in value of their 529 plan - such as if the stock market dips - is a prepaid tuition plan, says Lauren Foster, a Chicago-based CPA and personal financial specialist.

Prepaid tuition plans offer families the opportunity to buy tomorrow's tuition at today's prices, and they don't have to buy several years at once. If parents are able to buy one semester's worth of tuition over the course of a few years, they're still helping their children, she says.

[Learn how to find 529 plans that offer high growth.]

2. Don't neglect to estimate potential financial aid: Single parents who are divorced shouldn't worry about whether the other parent's income could affect their children's eligibility for need-based grants and scholarships in college. Federal financial aid is awarded based on the income of the parent who takes care of the child financially and with whom the child physically lives for six months or more of the year.

Whether or not a parent is divorced, all income - including alimony or child support - is considered in financial aid calculations, according to U.S. Department of Education guidelines. Parents who wanted to try to predict their child's financial aid can use the FAFSA4caster or net price calculators on school websites.

[Learn more about net price calculators.]

3. Don't forget state tax deductions and credits: In addition to any grants states offer, state income tax breaks can help boost college savings. Outlaw loves declaring her Idaho state income tax deduction for 529 contributions.

Up to $4,000 can be deducted from her income on her state tax return as a single person. If the money saved by a single parent on income tax was deposited into a 529 plan, thousands of dollars could be added to college funds.

[Find out how a state 529 plan can increase college savings.]

If a state has a 7 percent income tax rate and a parent contributes $4,000, he or she would save or get a refund of $280. Depositing that $280 into college savings each year for 10 years adds up to $2,800, before any interest is earned.

However, families should choose the 529 plan the state offers instead of a plan from another state in order to qualify for tax benefits, Foster says. Most states require families choose the state's plan in order to claim tax deductions or credits, she says.

Outlaw did choose her state's 529 plan. Reinvesting the tax deduction as well as investing more as her salary increased has become part of her overall college savings strategy for her daughter's education.

"My parents sent me to college debt-free," she says. "I want to do the same for my daughter."

Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.