This article originally appeared on www.thesavvycouple.com and was re-published here with permission.
You’re not alone if you want to start saving money for your kid’s college education but are still determining the best way to do it. The options for college savings are overwhelming, and it’s hard to know where to start!
Like many parents, you want to help your children afford college without student loan debt. This will put them a step ahead towards achieving financial freedom in their adult lives. That means it’s time to get a college savings plan in place so you can pay for college costs for your children without completely emptying your wallet.
This article will help you make an informed decision about which options will help you meet your financial goal, whether that’s paying for college fully, helping your kids with tuition, or even simply covering room and board expenses at their future college.
Different types of investment vehicles work best in different circumstances and financial situations. For many people, a 529 plan with Upromise is a great choice for saving for college expenses. In a 529 plan, your savings grow tax-free, and you don’t pay income tax on your withdrawals when they’re used for qualified education expenses.
Other places to save for your kid’s college expenses include Roth IRAs, brokerage accounts, bonds, custodial accounts, or education savings accounts. Explore the pros and cons of each option to make the choice that’s best for your situation.
6 Best Ways To Save For College
Table of Contents
- 529 Plans
529 plans are investment accounts that allow you to save money for your child’s future education costs. Your after-tax contributions grow tax-free, and all of the earnings can be withdrawn without being taxed as long as they’re used to pay qualified higher education expenses. The tax benefits of 529 plans make them one of the best ways to save for college.
Upromise 529 college savings plans allow monthly bank contributions as well as gifts from friends and family. A great feature is an opportunity to earn cashback rewards from shopping, dining, and paying with the Upromise Mastercard that is automatically deposited to the 529!
You can choose to invest in a 529 plan that is sponsored by the state where you live, or one that’s sponsored by another state. Contributions may be deductible on your state income tax return if you are contributing to an in-state plan. Some states even offer an income tax deduction for any 529 plan even if it’s in a different state.
Open a Upromise 529 for free today!
Pros:
- Anyone over the age of 18 can open a 529 plan, no matter what their gross income is.
- If you decide not to use this account for one child’s education costs, you can always change the beneficiary to another family member.
- You have flexibility in using the funds, such as using your 529 distributions to pay tuition for elementary or secondary public or private schools. Up to $10,000 can also be used to make qualified payments on student loans.
- 529 plans have favorable financial aid treatment because they are typically considered parental assets on the Free Application for Federal Student Aid (FAFSA), which negatively affects financial aid eligibility less than student assets.
Cons
- You pay income taxes and a 10% penalty on 529 plan withdrawals if the funds are not used for qualified expenses like college tuition, fees, room and board, textbooks, etc.
- Roth IRAs
While IRAs are typically thought of as retirement accounts, they are another good way to save money for your kids’ higher education expenses. With a Roth IRA, you contribute after-tax money, and it grows tax-free.
You have a multitude of investment options inside a Roth IRA such as mutual funds, real estate investment trusts (REITs), bonds, and more. Once the account has been open for five years, you can withdraw your contributions (but not your earnings) at any time without paying taxes or penalties.
Contributions to a Roth IRA are not tax-deductible. However, unlike 529 savings plans, the funds in your IRA do not have to be used for qualified education expenses to avoid taxes and penalties.
Pros:
- You can use the money for any purpose rather than being limited to paying for only college expenses like tuition.
- This is a tax-advantaged account, and your investments grow tax-free.
- There are lots of investment options inside an IRA.
Cons
- Contributions to a Roth IRA are capped at $6,000 per year as of 2021.
- You must wait five years after your first contribution before you’re able to withdraw your contributions without penalties.
- Since IRAs are retirement accounts, withdrawing earnings before age 59 ½ will result in penalties and taxes due on those funds.
- Brokerage Accounts
You can use a brokerage account as a way to save money for college costs, but you’ll be paying taxes on your earnings. Brokerage accounts are not tax-deferred, and you may be required to pay taxes on capital gains as well.
However, you can contribute however much you want no matter what your income is. Plus, you can control your investment options using investing apps like Robinhood or Betterment.
A downside to brokerage accounts is that they are counted in your assets when calculating financial aid, and can negatively affect your child’s financial aid eligibility for student loans.
Pros:
- There are no income limitations for contributions to this type of account.
- No contribution limits exist, so you can invest as much as you want in a brokerage account.
- You can use this money to pay any expenses, not just ones that are “qualified.”
Cons
- There are no tax benefits for this type of account.
- These accounts are not favorable to getting financial aid.
- U.S. Savings Bonds
Savings bonds can make a good addition to any college savings strategy because the government backs them, may have guaranteed returns, and may be inflation-adjusted. But while bonds are generally considered safe investments, investing in riskier investments like stocks could be more lucrative over time.
You can buy both EE and I bonds online through the government website Treasury Direct. These bonds are eligible for the education savings bond program which can allow you to take a tax exemption on some or all interest earned if the bond is used to pay for qualified education expenses for yourself or your dependents.
With EE bonds, you’ll earn a fixed rate of interest over the life of the bond, and the government guarantees that it will double in value by the date it matures. In contrast, I bonds have both a fixed interest rate and an adjustable, inflation-based interest rate but no guaranteed value.
Similar to 529 plans, if you buy U.S. Savings Bonds and hold them until they mature, any earnings from those investments will be tax-free as long as they’re used to pay for college costs that are specifically tuition-related. The funds can’t be used for room, board, books, or extracurricular activities under the education savings bond program.
Pros:
- As long as the savings bonds are used to pay for qualified expenses, the earnings on the bonds are tax-free.
- Bonds are safe investments that are not subject to market fluctuations and are protected against inflation.
Cons
- Savings bonds may be purchased in increments of $50 up to a maximum of $10,000 per year per Social Security number, so there is a limit to how much you can buy.
- If your child doesn’t use all of his or her savings bond earnings in the same year they’re earned, he or she can’t reap any benefits from an increased interest rate when it’s time to cash them in at maturity.
- Typically lower returns than stocks.
- Custodial Accounts
A custodial account, often called “UGMA” (for Uniform Gift to Minors Act), is an investment account that allows someone under the age of 18 to own investments and other types of property. When your child turns 18 years old, they will get complete control over this account.
In most cases, you have the option of naming anyone as the custodian for a UGMA account provided they are at least 18 years old and live in the same state as you. The custodial duty is usually taken on by one of the child’s parents or whoever opens the account, such as one of the child’s grandparents.
You can purchase publicly traded assets inside of the UGMA, including bonds, mutual funds, and stocks. But you are not permitted to invest in things like derivatives or buy on margin. The custodian must act in the beneficiary’s best interest when making management decisions in the fund.
Pros
- You can use this account to save for any expense your child incurs, not just college.
- Earnings are taxed only at the minor’s tax rate, not the parents’ tax rate.
- You can contribute up to $15,000 per year (or $30,000 for a married couple) without getting hit with the federal gift tax.
Cons
- Contributions are not tax-deferred nor income tax-deductible.
- Money in the account is considered an asset of the child. When applying for financial aid, this may impact their ability to get a student loan.
- Education Savings Account (ESA) or Education IRA
A Coverdell Education Savings Account (ESA) is a tax-advantaged account that can fit quite well into your college savings plan. Also known as education IRAs, ESAs are very similar to 529 plans. Like 529 college savings plans, your earnings and withdrawals are not taxed as long as they are spent on qualified education expenses.
The main difference between an ESA and a 529 plan is the significantly lower contribution limits. One great thing about ESAs is that anyone can open one, not just the parents or legal guardians of a minor. The beneficiary does not need to be the account holder’s child or have any specific relationship with them, which means anyone can open this account for your child.
You can also use an ESA to save money for K-12 tuition expenses up to $10,000, as well as supplies, books, and tutoring associated with enrollment at an eligible school. As with a 529 plan, if withdrawals are used for ineligible expenses, they are subject to tax and a penalty of 10 percent.
Pros
- You have more control over your investment options compared to a 529 plan which has more limited investment options depending on the program manager.
- The ESA is considered an asset of the parents, not the child when applying for a student loan or other financial aid.
Cons
- Income limits of $95,000 for single filers and $190,000 for joint filers (with phase-out limits) may mean your family is not eligible for an ESA.
- Lower maximum contribution limits per child than a 529 plan, limited at $2,000 per child per year total (regardless of how many people contribute for the same child).
- The ESA cannot be funded after the beneficiary turns 18.
- If the funds in the ESA are not used for college, they will be distributed to your child rather than refunded to you when the child turns 30, and the distributions are subject to earnings tax and a 10% penalty.
3 Tips To Saving For College
- Budgeting & Frugal Living
To start saving money for college, it is important to create a budget. If you need help with this, we suggest using Mint to figure out how much you’re spending. Once you know your spending, you can figure out which expenses to cut so you can save more for your children’s college.
When you’re just starting to save money and you’re still considering your investment options, the CIT Bank Savings Builder account will reward you for saving with a higher-than-average interest rate. Savings accounts aren’t the best place to keep your kid’s college money, but it’s a good place to start.
An easy way to live more frugally is by getting cash back when you shop. Two of our favorite sites to use are Ratuken and Ebates. They’re free to join and free to use, and they have hundreds of stores where you can earn cash back at.
You can also scan your grocery receipts with Ibotta to earn cash back on the things you were already going to purchase anyway. These small amounts of savings add up and will translate to less student loan debt for your children when they go to college.
- Setting Financial Goals
You’ll want to start figuring out how your college savings plan fits into your overall financial plan well before your kids enter high school. If your kids are already growing up quickly, there are still ways to save money fast so you can grow your college savings as soon as possible.
First, decide if you’re saving for your children to attend state public college or private college since these could mean very different dollar amounts. You may not know exactly what college they want to attend until they are in late high school, but you can get a ballpark college saving goal by looking up average college costs in your area and in other states.
Once you have a goal, you can figure out what steps you need to take to get there. For instance, if your goal is to save $25,000 towards your child’s college education by the time they go off to school, you can do the math to see how much money you’d need to save each month until they turn 18 to reach your goal.
Or, maybe your goal is to max out your contributions to a certain type of tax-advantaged account each year. Knowing what this contribution amount is will help you know how much you need to find in your budget to meet your college savings goals.
- Invest To Earn More
If you’re saving money for a goal that’s far out in the future, like your young child’s eventual college education, compound interest will help it grow faster over time. Rather than keeping money in a savings account for 18 years, you can earn more money by investing it.
Getting started with investing is easy. There are several different types of investment accounts available for college savings. Upromise 529 Plans, UGMAs, Roth IRAs, and Coverdell ESAs, are all examples of ways to invest money for your child’s education.
You can also invest as much as you want, without income or contribution limits, in brokerage accounts. Robinhood allows investors to buy and sell stocks commission-free. Betterment is an automated investing app that helps you create a personalized plan based on how much risk you’re willing to take and your investment timeframe.
Final Thoughts
There are many ways to save money for your children’s higher education before they reach college age. Do your research and choose the option that best fits your goals. Be sure to consider the pros and cons of each way to save for college before picking the one right for you.
Whether through a 529 plan, UGMA, ESA, or IRA, many options are available to parents and guardians who want to save money towards education expenses for their kids. A Upromise 529 plan is one of the best savings options to cover your child’s future education costs. It offers tax-free growth and withdrawals that can be used at any accredited college or university in the United States.
It’s easy to open a Upromise account and start earning rewards towards your kid’s college savings today!
Be prepared for your child’s decision to go to an out-of-state public college or expensive private school. Make sure you’re budgeting each month so that you can save enough money to invest in these accounts.
By setting financial goals and sticking to your budget, you can take control of your money and set yourself up to successfully save enough to send your kids to college.