How to save for college: 8 ways to get started now


The 18-year clock starts ticking the moment your child is born.

A college degree, despite the rising cost of tuition, remains a major achievement in the modern economy. You are more likely to have a job and earn a decent salary the more education you receive.

Yet many families aren’t preparing. Just 56 percent of parents are actively saving for their child’s education, according to Sallie Mae, and hold an average of only $18,135. That wouldn’t cover one year of tuition, fees and room and board at an in-state public institution, according to the College Board.

The outrageous price tag for higher education, coupled with a lack of parental savings and the economic benefit of actually going to college, has led to historic levels of student loans. Many graduates leave school with a yoke tied around their neck, pushing back their ability to buy a house and start a family.

When should you start saving for college?

As with any investment, the earlier you save, the more time your money has to grow. Some parents choose to start college accounts for their children before they’re born or around their first birthday.

“A parent, grandparent, guardian or really anybody else who wishes to fund to that child’s future educational expenses should start in my opinion right away, if not when they’re born,” says Joseph Voellm, a certified financial fiduciary at the JL Smith Group in Avon, Ohio. “This would allow the money to grow and compound over time to meet that future.”

If you haven’t started saving and your child is nearing high school or later, there’s still value in opening an account. Vanguard reports that by choosing an account with tax benefits, you’ll still have time to take advantage of them — and “be in an even better position” than not saving at all.

How much should you save for college each month?

The cost of college is steadily rising, but you might not need to save the full amount. In order to make saving more manageable, some experts recommend saving only one-third of the expected costs. The remaining two-thirds can be paid over a lifetime through loans, grants and future income.

To determine the set amount, research projected costs of a desired public or private school, look at current projections and divide by the number of months remaining until your child heads off to school. Incorporate the amount into your monthly budget.

Of course, calculating the total cost — and taking inflation into consideration — can get technical, Voellm says. He recommends meeting with a financial adviser so you’re not under-saving.

Which is the right account for you?

The following are several types of accounts people use to save for their children’s college education. By doing your homework — and possibly speaking with an adviser — you’ll have a better sense of where to park the money you’re setting aside for your child’s future.

1. Traditional savings account

What is it?

A savings account is something everyone should have — a storage place for short-term savings and emergency funds. Today’s best high-yield, nationally available savings accounts pay around 2 percent APY.

The benefits of storing college savings here

A savings account is one of the safest places to keep money you’re planning to use in the near future. As long as the money is in an account insured by the Federal Deposit Insurance Corp. (or the National Credit Union Administration), you’ll still have savings even if your bank goes belly up. You’re also guaranteed to earn interest on top of the money you deposit.

The drawbacks

According to Sallie Mae, college-saving parents have nearly $4,000 parked in savings accounts. But you’ll need to be careful when keeping college savings in a traditional bank account.

“There is an asset protection allowance, or APA, that protects a portion of the parents’ assets, based on the age of the older parent,” when determining financial aid, says Mark Kantrowitz, an expert on student financial aid.

Because financial aid is determined based on income and assets from prior years, students with sizable savings in their name could end up with a less generous package. Also, savings account yields pale in comparison to what you would earn by taking on more risk. The S&P 500, for example, has delivered an average total return of nearly 12.29 percent over the past five years, according to Morningstar.

You take on more risk by investing your money. But keeping college savings in a standard savings account may not be helpful if you’re trying to quickly reach your savings goal.

2. 529 college plans

What is it?

A 529 plan is a tax-advantaged savings account that can be used to cover higher education expenses. Operating in a fashion similar to a Roth IRA, 529 college savings plans allow parents to invest after-tax money into diversified, low-cost stock and bond funds and then withdraw the money tax-free for qualified education expenses.

The benefits of storing college savings here

Parents wanting to get a head start on saving for college can open a 529 plan as soon as their child is born. Workers in some cases may have access to employer-sponsored 529 plans at work.

Money in these accounts can be used for undergraduate or graduate studies at an accredited two- or four-year campus in the United States. If your child never goes to college, the beneficiary can always be changed.

Thanks to the Tax Cuts and Jobs Act of 2017, parents can use 529 plan funds to cover non-college expenses. Savings can be rolled over into an ABLE account that covers expenses for disabled children and young adults. They can also cover a portion of tuition each year (up to $10,000 per beneficiary) for K-12 students attending a private school.

These accounts offer big tax advantages, says Craig Parkin, a regional managing director at TIAA-CREF, the investment organization that administers state-sponsored college savings plans in California, Kentucky and other states.

“The gains on the accounts are tax-deferred, and once the funds are used to pay for qualified tuition expenses, parents will never pay taxes on those funds,” Parkin says.

Some age-based investment packages work like a target-date fund in your 401(k) – contributions are placed in stock-heavy investments when the child is young, then are automatically reallocated to a higher percentage of bonds and even cash as the child nears college age.

The drawbacks

Some states haven’t made changes to their tax code. That means you could pay additional taxes and penalties at the state level even though withdrawals are tax-free at the federal level.

Also, if you don’t actually use the money in a 529 plan for education, you’ll be subject to a penalty. 529 college savings funds can only be withdrawn tax-free for qualified education expenses, including tuition, books, fees, supplies, and room and board. Money spent on unqualified expenses is subject to income tax and a 10 percent penalty on earnings.

There are also restrictions on how money in these plans can be invested. For instance, account owners can switch the investments in their plan only twice a year.

3. Roth IRA

What is it?

A Roth IRA is an account used to store long-term retirement savings. Contributions are made using after-tax dollars. That means the withdrawals you make when you retire will be tax-free, but you won’t be able to qualify for a deduction when you file your tax return.

The benefits of storing college savings here

The savings in a Roth IRA grow tax-free. What’s more, Roth IRAs provide flexibility. Once your child finishes school, the rest of the funds in the account can be reserved for retirement.

Restrictions on Roth IRA withdrawals keep investors from taking earnings out penalty-free until age 59 1/2. But there are exceptions to this rule that allow early withdrawals due to certain circumstances. For example, if you’ve had the account open for at least five years, the contributions made to your Roth IRA can be taken out without penalty and used to cover qualified education expenses.

“So if you need the money for your child’s freshman year, open the account five years before the summer after your child graduates high school between seventh and eighth grade, unless there is a gap year planned,” says Gordon Achtermann, founder of Your Best Path Financial Planning in Fairfax, Virginia.

The drawbacks

The average cost of attending a public, four-year, in-state school for a single year is more than $21,000. But annual Roth IRA contributions are currently limited to $6,000. If you wait until the last minute to start saving, it’s not possible to cover four years of school solely by keeping money in a Roth IRA.

Another downside: While having a Roth IRA won’t count against you when it’s time for your child to apply for financial aid, the withdrawals you make will be considered income, potentially reducing your child’s eligibility for aid in future school years.

Also, keep in mind that any money used to pay for college limits the amount that’s available to you in retirement. Students can always take out loans if needed, but you can’t take out a loan if you’re running short on cash in retirement.

4. Coverdell education savings account

What is it?

A Coverdell education savings account is an alternative to a 529 plan. These accounts are designed to help families pay for college and cover elementary and secondary education expenses.

The benefits of storing college savings here

Both 529 plans and Coverdell ESAs allow families to make contributions using after-tax dollars and savings grow tax-free. And for both accounts, withdrawals are tax-free as long as the savings are used to cover certain costs.

One key difference is that Coverdell ESAs offer parents more flexibility in terms of what’s considered a qualified education expense. In addition to tuition for primary and secondary schools, savings from a Coverdell ESA can cover uniforms, tutoring programs and other K-12 expenses without triggering a penalty.

The drawbacks

The biggest downside to Coverdell ESAs is the low contribution limit. Parents can only contribute up to $2,000 per beneficiary per year. Contribution limits for 529 plans vary by program and by state, but allow families to set aside hundreds of thousands of dollars for their children.

Contributions to a Coverdell ESA cannot be made for children over age 18, and all funds must be withdrawn by age 30.

5. Prepaid tuition plans

What is it?

A prepaid tuition plan is an alternative to a 529 savings plan that may appeal to some parents. Designed for parents who are sure that their child will attend an in-state public university, this plan allows parents to simply pay for tuition credits in advance at a predetermined price.

The benefits of storing college savings here

Prepaid 529 plans retain the same tax, financial aid and parental protections as 529 college savings plans, but without being subject to swings in the stock market. There’s the opportunity to lock in today’s tuition rates, which will be helpful as college costs continue to rise. Even if your child changes schools, there may be a chance to get a refund or transfer funds over.

The drawbacks

Typically, prepaid plans are available for students when they (or their parents) are residents of the state where the public college or university is located. If your child decides to go away for college or wants to attend a private school, you may be able to transfer over an amount equal to their current in-state weighted average tuition and fees. But that leaves parents having to find a way to cover the remaining costs.

Like 529 college savings plans, prepaid plan holders can change beneficiaries at any time, but must pay a 10 percent penalty plus income tax on funds used for anything other than college tuition.

“You can have the prepaid plan to pay for tuition and a 529 college savings plan to pay for other expenses,” says Parkin from TIAA-CREF.

6. UGMA or UTMA accounts

What is it?

UGMA and UTMA custodial accounts allow adults to transfer assets to children under age 18 and offer tax breaks. UGMA stands for the Uniform Gift to Minors Act. UTMA stands for Uniform Transfer to Minors Act.

The benefits of storing college savings here

In these accounts, a portion of the gains is tax-free, part of it is taxed at the child’s income tax rate and the remainder is taxed at the parent’s income tax rate. Plus, there are no restrictions on how the funds may be used as long as they directly benefit the child.

There’s also more flexibility when investing and contributing to custodial accounts. With 529 plans, investment opportunities are limited and only cash contributions can be made. Contributions to UGMA accounts can be made using cash and investments like stocks and bonds. Additional options for contributing to UTMA accounts include assets like art and real estate.

The drawbacks

The downside of UGMA and UTMA accounts is that parents have less control over how the child eventually spends the money, says Michael Kay, certified financial planner and president of Financial Life Focus, a financial planning firm in Livingston, New Jersey.

“If money is in a UTMA or a UGMA account, it becomes (the beneficiary’s) at the age of majority, which is 18 to 21, depending on the state,” he says. “There’s no legal way to prevent the child from using money that was intended for college or a house to go to Europe.”

Something else to consider is the potentially negative effect these accounts can have on a child’s ability to qualify for financial aid once he or she is in possession of the assets.

7. Trusts

What is it?

An educational trust is another option for parents trying to save for their child’s future. A trust can be set up when an individual wants to hold assets on behalf of another person with the intention of eventually handing them over.

The benefits of storing college savings here

A trust can give a beneficiary (the person receiving the trust funds) more flexibility. In addition to paying for school, the trust can indicate that the funds be used for other purposes. A trust can also be beneficial for individuals who want to transfer assets and minimize their estate tax burden.

The drawbacks

Taxation rules vary depending on the kind of trust you’re setting up. Whoever is passing along their assets could possibly find themselves paying income taxes. Beneficiaries should prepare to pay income taxes on trust fund earnings.

When an educational trust is created, the terms of the trust should indicate that the trust funds should be used to pay for education expenses. A child’s ability to use the funds to cover other expenses could ultimately be problematic.

“A lot of times it’s controlling the money so that it can be used for higher education purposes, but also limiting the child’s access so that they don’t spend it irresponsibly,” says Kristian Finfrock, founder of Retirement Income Strategies in Madison, Wisconsin.

Another problem could arise when it’s time to apply for student aid. If parents aren’t careful, trust funds (which are often counted as the child’s assets) can reduce a child’s eligibility for loans and other forms of financial assistance.

8. Treasury bonds

What is it?

A bond is often called an IOU. An agreement is established so that one party loans money to another in exchange for the original deposit, plus interest when the bond matures. A Treasury bond is issued by the U.S. government. They can be purchased directly from the U.S. Treasury or through a bank or broker.

The benefits of storing college savings here

Savings bonds could be a solid option for parents opposed to taking risks when it comes to saving for their child’s college education. Investments are virtually risk-free since they’re backed by the federal government.

Interest on new Series EE Bonds and Series I Bonds is tax-free when it’s used to cover qualified education expenses (or the savings are transferred over to a 529 plan).

The drawbacks

While there’s not much to lose by investing in Treasury bonds, there’s also not much to gain in the form of returns. That’s why Finfrock isn’t a fan of relying on savings bonds to cover college costs. What’s more, he says, not everyone qualifies for favorable tax treatment. Indeed, there are income limitations for high net worth individuals.

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