How to Save for College in a Rising Interest Rate Environment

As families prepare for the financial demands of higher education, the current rising interest rate environment presents unique challenges and opportunities. Saving for college requires strategic planning, particularly when interest rates affect savings accounts, loans, and investment options. This blog post will explore effective strategies to save for college amidst these economic conditions. 

Understanding the Impact of Rising Interest Rates 

Rising interest rates can have a significant impact on your college savings strategy. Here’s how: 

• Savings Accounts: Traditional savings accounts typically offer lower interest rates, which may not keep pace with inflation. In contrast, high-yield savings accounts can provide better returns. As rates rise, these accounts may become more attractive, but it’s essential to compare options regularly. 

• Student Loans: Federal and private student loans often have variable interest rates. As rates increase, the cost of borrowing rises, making it even more critical to save adequately to minimize future debt. 

Effective Strategies for College Savings 

1. Start Early and Automate Savings

Starting your college savings early allows you to take advantage of compound interest, where your money earns interest on both the initial principal and the accumulated interest from previous periods.  

For example, if you save $200 a month starting when your child is born, you could accumulate over $60,000 by the time they turn 18, assuming an average annual return of 6%. 

Set up automatic transfers from your checking account to a dedicated college savings account or investment vehicle. This “pay yourself first” approach ensures that saving becomes a priority rather than an afterthought. 

2. Open a 529 College Savings Plan

A 529 plan is one of the most effective tools for saving for college. Contributions grow tax-free, and withdrawals for qualified education expenses—such as tuition, room and board, and books—are also tax-free. Some states offer tax deductions or credits for contributions made to their state’s 529 plan. 

Most 529 plans offer a range of investment options, including age-based portfolios that automatically adjust risk as your child approaches college age. In a rising interest rate environment, consider funds that invest in equities or other growth-oriented assets that have the potential to outpace inflation. 

3. Explore High-Yield Savings Accounts

High-yield savings accounts often provide significantly higher interest rates than traditional savings accounts. Look for accounts with competitive annual percentage yields (APY) and no or low fees. Online banks often offer better rates than brick-and-mortar institutions due to lower overhead costs. 

High-yield savings accounts offer liquidity, allowing you to access funds when needed without penalties. This flexibility is crucial as you may need to withdraw money for tuition payments or other expenses. 

4. Reevaluate Spending Habits

Developing a budget that prioritizes college savings can help identify areas where you can cut back on discretionary spending. For instance: 

• Dining Out: Reducing dining out from three times a week to once can save hundreds each month. 

• Subscriptions: Canceling unused subscriptions (streaming services, gym memberships) can free up additional funds. 

Establish specific savings goals based on projected college costs. For example, if you estimate needing $100,000 by the time your child is ready for college, break that down into monthly contributions over the years leading up to enrollment. 

5. Encourage Part-Time Work

Encouraging older students to take on part-time jobs can help them contribute directly to their college fund while gaining valuable work experience. Jobs such as tutoring younger students, working in retail, or summer internships can provide both income and skills. 

Use this opportunity to teach students about budgeting and saving. Encourage them to save a portion of their earnings specifically for college expenses. 

Utilizing Financial Aid and Scholarships 

1. Apply for Financial Aid

Completing the Free Application for Federal Student Aid (FAFSA) is essential for accessing federal grants and loans. The FAFSA considers family income and assets to determine eligibility for financial aid: 

• Deadlines: Be aware of deadlines; some states have limited funding available on a first-come-first-served basis. 

• Types of Aid: Understand the difference between grants (which do not need to be repaid), loans (which do), and work-study programs (which provide part-time work opportunities). 

2. Seek Scholarships

Scholarships are an excellent way to reduce college costs without incurring debt: 

• Research Opportunities: Encourage students to explore local scholarships offered by community organizations, businesses, and schools. 

• Diversity in Applications: Apply for scholarships based on merit, need, specific talents (like sports or arts), or demographic factors (like ethnicity or gender). 

Consider Alternative Funding Options 

1. Home Equity Lines of Credit (HELOCs)*

If you own a home, consider using a HELOC as a funding source for education expenses: 

• Lower Interest Rates: HELOCs often have lower interest rates compared to personal loans or credit cards. 

• Flexible Borrowing: You only borrow what you need when you need it, which can help manage cash flow during college years. 

2. Employer Benefits

Some employers offer educational benefits: 

• Tuition Reimbursement Programs: These programs can reimburse employees for tuition costs related to their education. 

• Dependent Education Benefits: Some companies also offer benefits specifically designed for employees’ children attending college. 

Saving for college in a rising interest rate environment requires proactive planning and strategic decision-making. By starting early with automated savings plans, utilizing tax-advantaged 529 plans, exploring high-yield savings accounts, reevaluating spending habits, encouraging part-time work among older students, and leveraging financial aid opportunities, families can effectively prepare for the financial demands of higher education. 

This article was written partially with information from the IRS website.  

Every investor’s situation is unique, and you should consider your investment goals, risk tolerance, and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. 

The foregoing information has been obtained from sources considered to be reliable; however, we do not guarantee that it is accurate or complete; it is not a statement of all available data necessary for making an investment decision and does not constitute a recommendation. 

Any opinions are those of Jonathan Meaney and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including asset allocation and diversification. 

While we are familiar with the tax provisions of the issues presented herein as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. 

Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for eligible education expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible education expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated.  

Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.  

*Raymond James Financial Services and your Raymond James Financial Advisors do not solicit or offer residential mortgage products and are unable to offer or negotiate terms of any such loan.