There are a variety of reasons you may want to save for your child’s college. Maybe you’d like them to graduate college without a huge financial burden. Or perhaps your goal is to save on taxes or encourage your child to continue their education after high school.
Regardless of why you believe it’s important to help your child pay for college, rest assured there are a number of saving for college options at your disposal. Each option comes with its own set of pros and cons so it’s a good idea to explore all of them. By doing so, you can pursue the right one for your unique child and situation. Let’s dive deeper into the top saving for college options.
You can save for your child’s college in a savings account. If you go this route and your child does not go to college, you can use the money to meet another financial priority such as retirement.
The greatest drawback to saving for college with savings accounts, however, is that they typically earn low interest rates. So it may take a lot more time to reach your college savings goals with them. Unsure of how much you’ll need to save? Check out our handy college savings calculator.
In addition, you might find it more difficult to stay on track with saving for college because you’ll be able to easily access your funds at any time. You may be tempted to withdraw the money and use it toward a vacation or home improvement project.
While savings accounts are a safe way to save for college, they won’t give you a high return on your investment. If you’d really like to make some progress on saving for college, you’re probably better off with an alternative option.
In the event you do decide to save for college with a savings account, opt for a high-yield savings account rather than traditional one. You may be able to score an interest rate of 2% or higher whereas a traditional savings account may only yield .01%.
CDs and Savings Bonds
If you’re in search of a risk-free way to save for college, a savings bond or CD can be a viable solution. Since it’s backed by the federal government, any investments you make with a savings bond pose virtually no risk. You won’t miss out on any principal and your child won’t be able to access the funds while they’re young, making it more likely that they’ll be used for college.
A CD is another risk-free college savings option because it offers a guaranteed return and fixed maturity rate. If you keep your money in a CD for a set period of time, you’ll be able to redeem it for your initial investment plus any interest you earned once your term is up.
While savings bonds and CDs are ideal if you’d like your money to grow risk-free until you need it to pay for college expenses, their minimal tax benefits and low returns make them less desirable than other college savings options.
You can use a Coverdell Education Savings Account (ESA) to save for your child’s college when they’re under the age of 18. A Coverdell ESA is similar to a 529 plan in that it can help you ensure your savings are used for tuition, books, room and board, and other college-related costs.
When you withdraw from a Coverdell ESA, you won’t have to pay any federal taxes on it, as long as you use the money on qualified expenses. Another benefit of a Coverdell ESA is that you may secure Federal Deposit Insurance Corporation (FDIC) coverage, depending on the investments you choose.
Although the Coverdell ESA may be a good option, it’s important to understand its restrictions. It will only allow you to contribute up to $2,000 per year per child. Since the cost of higher education is increasing every year, saving $2,000 per year for 18 years or a total of $36,000 may not be enough to cover a lot of your child’s college, even with compound interest.
Also, the Coverdell ESA will require you to use the money or transfer it to another beneficiary before your child turns 30. Additionally, if your modified adjusted gross income is higher than $110,000 or $220,000 on a joint tax return, the Coverdell ESA is not available to you.
When most people think of a Roth IRA, retirement is usually the first thing that comes to mind. Although a Roth IRA can be a powerful tool for retirement savings, it’s also one of the top college savings options. With a Roth IRA, you can save and invest after-tax money and help pay for college.
A Roth IRA will allow you to withdraw up to the amount you’ve contributed at any time for any reason without any taxes or penalties. So if you’ve contributed $30,000 and your Roth IRA has grown to $50,000, you can take out $30,000 whenever you’d like. You can save money today and later decide if you’d like to allocate it toward college or retirement.
The disadvantage with using a Roth IRA to save for college is that there are contribution limits. You can only contribute up to $6,000 per year if you’re under 50 and up to $7,000 if you’re older than 50. Also, a Roth IRA is not an option if you’re a single tax filer with a gross income of more than $139,000 or a married filer who earns more than $206,000.
Ideally, your child will go to college and land a great job after graduation. The reality, however, life doesn’t always go as planned. If you’re unsure of whether your child will attend college but still want to save for their future, a custodial account can be a great idea. Two of the most common types of custodial accounts include UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act).
There are no restrictions on how you can use the funds of a custodial account. The only caveat is that the money needs to benefit your child in some way. Custodial accounts also offer tax breaks. While the initial $1,000 is tax-free, the second $1,000 is taxed at your child’s income tax rate and the remaining is taxed at your income tax rate.
Perhaps the most noteworthy downfall of custodial accounts is that they don’t give you much control over how your child uses the money. Once your child turns 18, you won’t be able to tell them what to do with the funds. They can put them toward a vacation to Europe or a luxury car instead of college if they wish.
529 College Savings Plan
529 college savings plans are one of the most popular college savings options. A 529 plan earnings can grow tax-free and won’t be taxed when you choose to withdraw funds, as long as you use them for qualifying college expenses. While a 529 college savings plan is similar to a Roth IRA, there are no limits to how much you can contribute each year.
You’ll be able to save as much as you’d like until your account reaches a certain balance which is usually $400,00 or more. Also, there are no income caps which may disqualify you from using a 529 to save for college. A 529 is an option regardless of whether you make $20,000 per year or $20 million per year.
529 plans offer age-based investment options which can make saving for college simple yet effective. If you prefer to create your own portfolio, however, you can do so well. Depending on the state you live in, you may get a tax break or credit for contributing to a 529 college savings plan.
The most significant downfall of a 529 plan is that if your child doesn’t end up going to college and you don’t have another child to transfer the funds to, you’ll be on the hook for taxes and a 10% penalty fee. Other drawbacks include high fees or limited investment options but you can avoid them by doing your research and choosing the right plan.
So opening a 529 college savings plan is best if you’re fairly confident your child will go to college and would like to save as much as possible while reaping some tax benefits.
Save for Your Child’s College Education with our Easy-to-Use App
Here at UNest, we are strong advocates of saving for college with a 529 plan. If you’re interested in setting up a 529 for your child (or grandchild, niece, nephew, or anyone else), the U-Nest mobile app is an invaluable resource.
As long as you’re willing to invest at least $25 per month, you’ll find that our app makes savings for college a breeze. Download the U-Nest mobile app and begin saving for your child’s college today!
This material is for informational purposes only and should not be construed as financial, legal, or tax advice. You should consult your own financial, legal, and tax advisors before engaging in any transaction. Information, including hypothetical projections of finances, may not take into account taxes, commissions, or other factors which may significantly affect potential outcomes. This material should not be considered an offer or recommendation to buy or sell a security. While information and sources are believed to be accurate, UNest does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information.