Ways to Save for Your Child’s College Education

The cost of college education and accompanying expenses have soared. The earlier you start saving, the better prepared you’ll be for future costs. There are numerous ways to save for your child’s college education. Here are some of the most effective methods:

529 plan

Contributions to a 529 plan can be invested, with each plan offering varying investment choices. The earnings are not taxable if the distributions are used for qualified education expenses such as tuition, room/board, equipment, and books. Some states even allow a tax deduction or credit each year you contribute, depending on the plan and state. If you don’t use all the funds, they can be transferred to other family members for their education. Additionally, up to $35,000 of leftover funds can now be rolled into a Roth IRA, provided the account has been open for at least 15 years.

Education Savings Account (ESA) or Education (IRA)

An ESA is similar to a retirement account but is used exclusively for education expenses. You can contribute up to $2,000 per year per beneficiary, but the amount depends on your total adjusted gross income. If you earn too much ($220k for joint filers and $110k for single filers), you are not eligible to contribute. Contributions are not tax-deductible, but the earnings are not taxed as long as they are used for qualified education expenses. The account must be fully withdrawn by the time the beneficiary reaches age 30; otherwise, the remaining funds will be subject to taxes and a 10% penalty.

Roth IRA

While a Roth IRA is primarily for retirement, contributions (not earnings) can be withdrawn penalty-free for any reason, including education expenses. Contributions grow tax-free, and you can use the funds early without penalty for education expenses for yourself, your spouse, children, or even grandchildren. However, income tax on account earnings will still apply to education-related withdrawals.

UGMA or UTMA

You can gift or save into a UGMA/UTMA account and be listed as the custodian. There are no tax benefits, and the income generated (dividends, interest, and capital gains) is taxed to the minor each year. The parent would report the income on their tax return, and if the income is high enough, a separate return for the minor may be necessary. Control of the account transfers to the beneficiary once they reach the age of majority (18 or 21, depending on the state). At that point, they can use the funds for any purpose, not necessarily college. If the beneficiary doesn’t go to college, they can use the account for other plans, such as a house purchase or a wedding.

Traditional Savings Account or Brokerage

You can accumulate funds in a savings account or a brokerage account for college expenses. A savings account offers limited interest or potentially CDs from a bank. A brokerage account provides a wide range of investment options, such as cash, stocks, mutual funds, and ETFs. You will pay taxes annually on interest, dividends, and capital gains, so there is no tax advantage. However, this approach allows you to control the distribution of the funds completely, and there are no penalties if the money is redirected for another use.

Ways to Save Over the Years

Encourage grandparents and other family members to contribute to college savings accounts during holidays and birthdays instead of buying toys or other items. Even small deposits can add up significantly over time, especially if invested wisely.

You Cannot Finance Your Retirement!

Please always remember that you cannot finance your retirement.  Ensuring you are prepared for retirement takes precedence over college savings but it’s great if you can do both!  Honestly, you are the one in control of what you are spending and adjusting to save/plan for all the things important to you is necessary and achievable in most cases.

Start to Save Early

Keep in mind that each of these savings methods may be accounted for differently on the FAFSA. Be sure to research how your chosen savings strategy will affect your financial aid eligibility. By starting early and choosing the right savings plan, you can ensure that you are well-prepared for the future costs of college education.

Have questions? Feel free to contact us.