For many parents, saving for a child’s college education is a major source of stress. It’s often difficult, if not impossible, to know how much you actually need to save, as the cost of attending college varies wildly depending on the college and whether your child qualifies for financial aid. Without knowing what college your child will attend, how can you know how much money to put aside?
Furthermore, even if you do know what college your child will attend, the cost of attending is likely to change by the time your child is old enough to go. Besides, when should you start saving? The 2K Rule is an attempt at answering all of these questions.
What is the 2K Rule?
Invented by Fidelity Investments, the 2K Rule is a rule of thumb designed to help parents estimate how much money they should save to help pay for their child’s college education. It says that you should be saving $2,000 a year towards a college education every year. If you’re just starting out, simply multiply your child’s age by $2,000 to see how much money you need to catch up and afford half of the cost of an average college education. After that, you should continue setting aside $2,000 per year until your child goes to college.
For example, if you have a 10-year-old child, you should strive to have $20,000, or $2,000 times 10 years, already set aside, with $16,000 still left to save over the course of the next eight years. Essentially, under this system, you would aim to build a $36,000 college fund for your child.
According to Keith Bernhardt, vice president of retirement and college products of Fidelity, this would allow you to be “reasonably confident” of affording approximately half the cost of a four-year education at an in-state public university. Fidelity came up with the 2K Rule after a company survey discovered that over two-thirds of parents wished there were more specific guidelines on how much to set aside for their child’s college education. “Different people have different financial goals, but the 2K rule provides a starting point,” Bernhardt says.
You must use a 529 plan
The main caveat of the 2K Rule is that it assumes you are using a 529 plan. This is a state-sponsored, tax-advantaged plan that can help increase your college savings. States offer a variety of different 529 plans that come with a number of benefits, the first of which is that investment earnings in a 529 plan are not subject to federal capital gains tax when used for qualified education expenses. According to the IRS, these expenses include college tuition, fees, books and other necessary supplies.
Additionally, thirty-three states and the District of Columbia will not tax investment earnings in a 529 plan, and five states will even offer an income tax deduction to residents for their contributions in the plan (these are Arizona, Kansas, Missouri, Montana and Pennsylvania).
However, finding the right 529 plan for you and your child can be tricky. There are two main types of 529 college savings plans: direct-sold plans and advisor-sold plans, though other types of plans also exist whose potential benefits you may wish to explore. According to a 2016 survey, almost three-quarters of investors did not know what a 529 plan is.
If you are part of that majority, and you are looking to maximize your tax breaks and set up your child for college success, make sure to talk with an investment advisor at your local financial institution. They’ll help you determine the best 529 plan and how much money to set aside for your child’s education.