Budgeting & Saving
Key takeaways
- 529 plans and prepaid tuition plans offer significant tax advantages.
- Mutual funds, Roth IRAs, and life insurance policies can be useful college savings tools.
- Trusts and corporations can be contributors to a Coverdell education savings account.
College is expensive, and it seems that it gets more costly every year. On average, in-state public colleges are most affordable, and public out-of-state costs may be twice as expensive. However private college costs can easily reach 4 times as much as public in-state schools. If you’re a parent of a future high-school grad, it’s wise to start saving for higher education expenses now.
Having a well-stocked college fund when the time comes will help reduce stress and financial worries. An established fund could also help expand the list of schools your child can attend. So, the sooner parents start saving for a child’s education, the better. In this article, we’ll explore how to start saving for college—from wherever you are in the process.
As you try to build a brighter financial future for yourself and your family, explore the tools and resources at Best Egg Financial Health. Our services are designed to help you understand your current status so you can chart a course toward financial wellness.
8 smart ways to save for college
Every college savings plan has advantages and disadvantages. And a family’s financial situation dictates which tack is best. Here are 8 methods to consider when saving for a college education. You may even choose a few to get the job done.
529 plans
A 529 plan is a good way to save for college expenses. And if it’s used for qualified higher education expenses, you won’t pay federal income tax on the money you save. Although a 529 plan originates in the federal government’s tax code, many states offer state tax benefits for in-state residents. (That applies in states that charge state income tax.) You can open a 529 plan for a beneficiary, such as a child, grandchild, or other family member as defined by the Internal Revenue Service. Others may add to the savings through official gift contributions to the account; some may receive tax advantages. You also can designate yourself as a beneficiary if you’re planning for your own future higher education needs.
There’s another version of the 529, called a prepaid tuition plan. This college savings strategy lets you buy tuition credits at today’s rates and lock in the costs. Prepaid plans are offered by state governments or private colleges to cover qualified education expenses. This prepaid 529 is a savings account that invests in stocks, bonds, and mutual funds. The returns pay for tuition when the time comes. Note, though, that prepaid 529 plans don’t usually cover room, board, books, or related education expenses.
Custodial accounts under UGMA/UTMA
Custodial accounts come in 2 forms; the Uniform Gift to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA). These savings accounts may contain cash, stocks, mutual funds, and other investment options. UTMAs may also hold real estate.
There’s no limit on how much you can invest into these accounts. But be cautious. You can’t change beneficiaries. And when the beneficiary turns 18 or 21, they’ll have full access to the money—for whatever purposes desired.
Qualified U.S. savings bonds
Buying savings bonds from the U.S. Department of the Treasury is an easy way to begin saving for college. You may also get an annual income tax break. When redeemed, if the money is used for qualified higher education expenses, the income might be excluded for tax purposes.
Regular Series EE savings bonds have a fixed interest rate for the first 20 years after they’re purchased. They’re guaranteed to double in value during that time and carry little to no risk. The interest rate for bonds purchased in early 2023 was 2.10%.
Series I savings bonds typically offer higher rates—6.89% in early 2023—and interest rates are subject to change twice a year. These bonds are limited to $10,000 each year per Social Security number. However, nothing prevents both parents (and child) from buying $10,000 in Series I bonds per year.
Roth IRA
The first thing many people think of when someone mentions an IRA is “retirement account.” But with a Roth IRA, you could invest after-tax dollars toward funding someone’s education with the proceeds. Earnings compound—tax free—until they’re withdrawn. If the prospective recipient decides not to attend college, the IRA’s owner continues to maintain it as a way of saving for retirement.
Coverdell ESA
A Coverdell education savings account (ESA) is a good way to save for college. But unlike many other plans, a Coverdell ESA can also be used for qualifiedelementary and secondary education expenses. Contributions are not tax-deductible. But earnings accrue tax-free, and distributions are free of income taxes, when spent on qualified educational expenses in a given tax year.
There are several caveats, though. All funds must be used by age 30 or tax penalties may be incurred. Total contributions, across all Coverdell ESA accounts established, may not exceed $2,000 annually per beneficiary. Individual contributor income limits also exist. However, trusts and corporations can contribute.
Mutual funds
Investing in mutual funds, including index funds, for education purposes may also be worth a look.
There’s no limit on amounts you can invest, and your money won’t be mandated to help fund education. However, you may pay income taxes and capital gains taxes on earnings. Your overall capital assets may impact a child’s financial aid eligibility.
If aid eligibility isn’t a concern, you might consider mutual funds for their range of investment types, risk levels, and returns.
Brokerage accounts
A brokerage account is a wide-ranging term. It’s an account that lets you buy and sell investment options like stocks, bonds, mutual funds, and other securities. In addition, many brokerage accounts also let you trade in silver, gold, and even real estate.
Although there are few, if any, tax benefits to these accounts, the investment opportunities are vast. And if the funds end up unused for education, the account holder keeps the assets without any spending restrictions.
Permanent life insurance policy
A life insurance policy might seem like a strange way to save for a child’s college expenses, but it’s actually a valid way to invest parent assets for education expenses. In a permanent policy, some premium goes toward a death benefit, and some goes into a tax-deferred savings account.
Some advantages of these policies are that your money can be accessed at any time, the savings aren’t limited to education expenses, andbesides eventually providing a death benefit, these policies can be used to shelter assets for family members. Additionally, life insurance isn’t counted when seeking financial aid.
Additional college education savings accounts
If the above savings methods aren’t for you, another type of IRA or savings account might be your choice. Any savings could help reduce long-term student loan debt—a major hardship for many graduates and their parents.
Across all options, laws and limitations vary, so be sure to research what best suits your situation and goals. Whatever method(s) you choose, remember that friends and family might like to contribute over the years. Choose at least 1 account that makes gifting simple or beneficial to them. As appropriate, let them know what accounts exist and that you’re happy to provide the details upon request.
Learning how to save for college
Saving for education expenses earlier rather than later has many advantages. With proper oversight, the money in college savings plans won’t go to waste. It could help your child get a college degree without racking up serious debt. The advantages of that often extend to financial stress reduction for parents, as well.
This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.
