As the cost of a college education continues to rise, students are graduating with more debt than ever before. According to U.S. News1, 2019 college graduates borrowed, on average, more than $30,000 to pay for school. So while starting a college fund for your child may seem like a daunting challenge today, it’s a smart strategy for giving them a financial advantage tomorrow.
No matter how young your child may be, it’s never too soon to start saving for their college. Here are some tips to help you start building a college fund:
Create a financial plan. Saving for college should not mean putting off your other financial obligations. If you haven’t already done this, create a plan for paying off your debts, establishing an emergency fund to cover three to six months of family expenses and setting up contributions to your retirement account(s). Once you have these obligations covered, assess how much you can regularly put away for college.
Take advantage of online resources. Online tools ranging from college websites to tuition calculators can help you estimate how much money your child may need to earn their degree. It helps to know what you’re aiming for!
If or when they are old enough, encourage your child to engage in the process. Talking openly with your children about the value of college, as well as its cost, can help motivate them to start saving, too. Make it a family goal and celebrate together when you reach certain milestones.
What’s the Best Fund for College Savings?
The return on regular savings accounts doesn’t typically keep up with inflation, so it makes sense to explore plans and accounts specifically designed for college savings. Here are some ways many parents choose to save for college:
529 Plan. Sponsored by a state or state agency, or an educational institution, a 529 plan (qualified tuition plan) allows you to save for your child’s college without paying tax on its earnings, as long as the funds are withdrawn for paying qualified higher-education expenses. Family and friends may make contributions to your child’s 529 account as well.
There are two types of 529 plans: education savings plans and prepaid tuition plans.
An education savings plan allows you to open an investment account (often with a choice of portfolio options) to save for college tuition, mandatory fees, and room and board. The funds may generally be used at any college or university in the U.S., and sometimes beyond the U.S.
A prepaid tuition plan allows you to purchase units (credits) at participating colleges and universities for future tuition and mandatory fees (not room and board) at today’s rates. Funds from this type of account must be used at a participating institution for the beneficiary to receive full value.
Read the details of any 529 plan you are considering closely to find out about any potential tax benefits, fees and expenses, residency requirements, restrictions, etc., as they may vary.
Coverdell Education Savings Account (ESA). Much like a 529 plan, a Coverdell ESA allows you to establish a savings fund for someone under the age of 18. However, these accounts are available only to those whose modified adjusted gross income falls below a certain limit (for 2021, the limit is $220,000 for a married couple filing jointly, or $110,000 for an individual). While the earnings from these accounts are tax-free, contributions are not tax-deductible. You may contribute a maximum of $2,000 annually per child, and the funds must be used before your child reaches the age of 30, or penalties may apply.
Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) Account. UGMA and UTMA custodial accounts allow you to contribute money to a beneficiary under the age of 18. The funds you contribute are transferred to this beneficiary when they reach the age of adulthood (18 to 25, depending on your state), to spend as they see fit. Unlike ESAs, these accounts allow you to contribute as much as you want annually, and the earnings are taxable. Be aware, too, that since there are no requirements that the funds be spent on educational expenses, you cannot guarantee that that they will go toward college.
Roth Individual Retirement Account (IRA). Although Roth IRAs are typically used for retirement savings, they can also be used to save for your child’s college expenses. Roth IRAs allow you to contribute after-tax funds while shielding earnings from taxes, meaning you don’t have to pay taxes when you withdraw the funds, as long as they are being used for qualifying educational expenses and you’ve been regularly contributing to the account for at least five years.
In addition to these options, some parents invest in savings bonds, mutual funds or other assets to save for their children’s college expenses. Whichever options you determine are right for you, remember that it is important to start as soon as you can so that those savings have time to grow.