College Saving Plans: 6 Options for Your Children's Future
If you’re looking for guidance on how to smartly save for your family’s college costs, our guide will outline the various products and saving strategies you might want to consider.
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Introduction
With an average annual cost of more than $35,000 per year, college has become one of the most significant expenses both students and their parents will undertake in their lives.
Such a significant expense requires years of planning and saving for many families to afford. But figuring out how to save for college — while also saving for retirement and other financial goals — is easier said than done.
On top of that, parents must choose between a number of different financial products designed to support college savings. With different advantages and limitations associated with each product, parents can’t settle for saving for college — they also need to make sure they’re doing it in the right way.
If you’re looking for guidance on how to smartly save for your family’s college costs, our guide will outline the various products and saving strategies you might want to consider.
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Chapter 1
The Rising Cost of a College Education
The cost of college keeps rising every year, placing financial strain on parents who want to help their children afford a college education. Across the country, college tuition increased by an average of 25% between 2008 and 2018.
Depending on where your children go to college and how much of their college education you want to cover, the monthly savings cost for college can vary widely. If your children attend a four-year public institution, for example, and you hope to cover roughly half of their college expenses, the CollegeBoard College Savings Calculator estimates you’ll need to save an average of $319 per month to cover those costs.
But these savings requirements can change dramatically if, for example, your child is accepted to a private four-year institution and you are determined to fully cover the cost of tuition. Assuming a 5% average increase in college tuition and a modest 5% return on your college savings and investments, you would need to save more than $1,200 per month starting at your child’s birth to safely afford the projected cost of their college education.
Depending on your savings goals, the task ahead may be daunting. The first step in creating a plan to achieve these savings goals is identifying the right tools and resources to help you build your child’s college fund.
Chapter 2
Six Ways To Save for Your Child’s College
Parents saving for their child’s future college expenses have a number of savings vehicles and tools to choose from. Each of these products offers its own strengths and weaknesses, though, and could have important implications to be aware of, such as tax considerations or your child’s eligibility for financial aid.
Before choosing a college savings product or strategy, research your options to find the best fit for your needs. Here’s a look at six financial products you may want to consider:
Chapter 3
College Savings Plans
A 529 college savings plan is a state-sponsored saving and investment fund designed specifically for saving for educational expenses. The funds in these accounts can be used tax-free to pay for qualifying expenses, including tuition, room and board, and books.
College savings plans can take two separate forms. The first is as a fund where money can be placed into mutual funds and other investments. Alternatively, a college savings plan can be used as a prepaid tuition fund, allowing families to pay for tuition in advance over time at the rate of tuition being charged now — rather than what you might pay after years or decades of tuition increases.
Pros:
- Earnings from contributions to a 529 college savings plan are tax-free as long as they’re applied to education expenses.
- A 529 plan allows for very high single-year contributions.
- You can change the beneficiary over time. If your oldest child earns a scholarship, for example, some or all of their 529 funds can be put toward educational costs for a younger sibling.
Cons:
- Risk/reward profiles mean your amount of earnings aren’t guaranteed.
- If your child doesn’t go to college or funds can’t be reassigned to a different beneficiary, you’ll likely have to pay a 10% penalty on any earnings.
- These funds can impact financial aid eligibility, leading to less grant money or other aid.
- Prepaid tuition plans are limited in availability and may restrict your child’s options when choosing where to attend college.
Chapter 4
Roth IRA
While the Roth individual retirement account (IRA) is intended to support retirement savings, this after-tax investment fund is sometimes utilized as a tool to save for college education expenses.
Contributions to a Roth can be withdrawn tax-free (and fee-free) when used to pay for educational expenses, unlike other IRAs. These tax advantages can beat the savings offered by a 529 plan and other college savings tools.
Pros:
- Roth IRAs offer flexibility if your child doesn’t go to college, earns scholarships or only needs a small amount of financial support.
- Even after withdrawing contributions from a Roth IRA, the earnings from those contributions will continue to grow tax-free to fund your retirement.
Cons:
- Roth IRAs have low maximum contribution amounts. This can make it difficult to save a substantial amount to pay for college expenses.
- The Roth IRA has income limits to be eligible to make contributions, and it must also be open for at least five years to withdraw contributions penalty-free.
- Only contributions can be withdrawn penalty-free to pay for college education expenses. Earnings are not eligible.
- By withdrawing from a Roth IRA, you’re taking money away from your retirement savings.
Chapter 5
Savings Bonds
While savings bonds were a more popular savings tool during periods of history where interest rates were more substantial, they may still be appealing as part of a larger college savings strategy.
Pros:
- Although rates for these bonds are lower than most other saving and investment options, they also don’t carry any risk, which may appeal to investors seeking a conservative savings approach.
- In some cases, earnings from these bonds may not be counted toward your gross household income.
Cons:
- Tax benefits are not guaranteed and will likely be insignificant.
- The rate of return for savings bonds is far lower than other investment options.
Chapter 6
Certificates of Deposit
Like savings bonds, a certificate of deposit (CD) offers a low-risk but flexible savings vehicle that can be customized to suit your desired savings term. Rates on a CD typically increase as the amount of your contribution and the term of the CD also increase.
Pros:
- The CD’s flexible term limits give you more options over other conservative savings vehicles.
- If your child is in college or close to starting college, some parents may prefer moving funds into a CD to lock in guaranteed earnings and protect their assets from depreciated value due to a recession or other economic volatility.
Cons:
- Like savings bonds, the earnings on a certificate of deposit are low.
Chapter 7
Coverdell Education Savings Accounts
Coverdell ESAs offer a number of different saving and investing options, and they’re designed specifically to help you save for educational costs related to K-12 schooling or sending a child to college.
Pros:
- Investments grow tax-free.
- Coverdell ESAs offer more flexible and diverse investment options than other saving options, such as a 529 plan.
Cons:
- Coverdell ESA contributions are limited to just $2,000 per year. Income restrictions can further limit the amount you’re able to save through this fund.
- Contributions can only be made until the beneficiary turns 18 years old.
- Changing the beneficiary of the account is more complicated than with other savings vehicles.
Chapter 8
Trusts
A living trust allows you to move money into a fund that your child can then use for educational expenses.
Pros:
- Parents and trustees have a lot of flexibility over how funds are used and managed.
- There are no limits to the amount of money you can place in a trust.
- Trusts can offer tax savings to parents.
Cons:
- Beneficiaries can do anything they want with the money, and parents will have no control.
Chapter 9
How To Compare Different College Savings Products
Struggling to decide which investment strategy — or combination of strategies — offer the best value and flexibility for your family?
Here are some criteria to consider:
- Investment growth over time
- Tax implications
- Annual contribution limits
- Impact on financial aid eligibility
- Flexibility in how savings are invested
- Withdrawal options if you don’t need those funds for college expenses
Keep in mind, too, that your ideal saving strategy might involve multiple savings products that provide different types of flexibility and risk.
Tips To Increase Your College Savings Efforts
Whether you need help increasing your college saving contributions or maximizing the return on your investment, here are some strategies you may want to consider:
- Start saving early. The earlier you start saving, the more you’re able to contribute to a savings fund — and the longer those contributions will be able to grow before you need them to cover educational expenses.
- Compare fees and historical performance when comparing 529s to other accounts. State-sponsored 529 funds are all managed separately, and the administrative fees and historical earnings can vary. No matter where you live, you can open a 529 plan sponsored by another state.
- Be mindful of your child’s potential eligibility for financial aid. Certain types of assets and sources of funding for college expenses may decrease your child’s ability to qualify for financial aid. A financial aid counselor can help you understand the best savings vehicles to maximize financial aid eligibility.
- Don’t forget about other college funding options (scholarships, student loans and so on). While parents may place pressure on themselves to financially support their child’s college education, the entirety of this funding doesn’t have to come from you.
- If you’re struggling to save, talk to a financial planning professional. Financial planners can help you understand your current income, your savings goals for retirement, college and other priorities, and help you build a strategy to achieve all of those goals.
The cost of saving for college can be daunting for both parents and children alike, but a saving and investing plan can help you break down this imposing task into more manageable savings habits and goals. By becoming a member of a local credit union, you can access financial products and other resources that will help you reach these goals while supporting your long-term financial security.
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