If you are a new parent or your kids are young, you’ll want to do one thing right now: Start putting money into a college savings plan. Having a college fund for kids is generally a surefire way to help transition your children to a successful adulthood.
And college, as we all know, isn’t cheap.
According to a U.S. News annual survey, the average tuition for the 2022-2023 school year ranged from $39,723 (for private colleges) to $10,423 (for public, in-state colleges). And unless something changes in how people pay for education, college costs will only keep rising.
If you’re looking into ways to save for college, here are some options:
Open a 529 Plan
You’re probably familiar with 529 plans, one of the best and most popular ways to have a college fund for kids. The savings plans, usually sponsored by state governments, encourage saving for future education costs. They often are tax-friendly in the sense that many states will let you deduct your contributions from your state income tax, and when you withdraw the money for college, the money won’t be taxed.
You can put money into your own state’s 529 or any other state’s plan. Like snowflakes, all state plans are not alike. So if you live in Idaho but like Indiana’s plan better, go for it.
But open up an account sooner rather than later. “It’s never too late to start saving for education, but we do encourage parents to start saving when their children are young. The more time the account has to grow, the more money kids will have available when they need it for education,” says Laura Morgan, vice president of communications, savings and legal affairs at College Foundation Inc., the nonprofit umbrella organization which oversees North Carolina’s NC 529 Plan.
It often doesn’t require much money to get started. In NC 529’s case, Morgan says you can open an account for $25.
The important thing, of course, is to keep contributing money to your child’s 529 every year and preferably every month. Otherwise, the interest on that $25 isn’t going to amount to all that much over the next 18 years.
In fact, a common mistake that parents make is setting up the 529 and then forgetting to fund it, according to Steve Azoury, owner of Azoury Financial, a financial planning firm in Troy, Michigan.
“It is best to schedule a systematic deposit each month into the plan, so it doesn’t get away from you. You should also notify your family members about the plan, so when it comes to birthdays and Christmas gifts, they can consider making deposits into it,” Azoury says.
Andrew Wood, a retirement planning advisor with Daniel A. White Associates in Middletown, Delaware, agrees that too many parents tend to procrastinate on opening up a 529 plan.
“With education costs continuing to climb, the time value investing is vital,” Wood says. “The most valuable dollar invested is the first dollar invested, with time and compounded interest. Don’t wait until it’s too late.”
But Wood points out that “time is also important on the back end.”
When your kids are reaching college age, you want to pay attention to your 529 and make sure it’s set up properly, he explains. In other words, you don’t want to be close to the finish line, where it’s time to use the money to pay for college, and then lose a lot of money due to a bad day in the stock market.
“Make sure you are revisiting risk tolerance within the plan the closer you get to using the funds for education expenses. If you’ll need the funds soon, you’ll likely want to consider scaling back on the risk,” Wood says.
Put Money Into Eligible Savings Bonds
Another way to start a college fund for kids: You can buy savings bonds digitally from the Treasury at TreasuryDirect.gov. They’re no longer issued in paper form.
“If you redeem them and use the money to pay for higher education, excluding room and board, you can exclude the income from their annual gross income for tax purposes,” says Ryan Eyerman, a certified financial planner at E&M Consulting in Westlake, Ohio.
“This is, of course, subject to certain restrictions,” Eyerman adds.
Some of the advantages of putting money into savings bonds is that they’re guaranteed by the government and extremely low to no risk. On the downside, the interest you’ll earn can be pretty low. Currently, individual Series EE savings bonds are earning an annual fixed rate of 0.10%. Series I savings bonds are currently earning a composite rate of 9.62%, a portion of which is indexed to inflation every six months.
Try a Coverdell Education Savings Account
A Coverdell Education Savings Account, known as an ESA, is “a tax-deferred trust account that can be used to pay for elementary, secondary and higher education expenses – room and board is permitted,” Eyerman says. “Earnings accumulate tax-free, and distributions are free of income taxes as long as the funds are used for educational purposes.”
Eyerman adds: “All funds must be used by age 30, or there may be tax penalties.”
There are other important considerations, however. You can’t put more than $2,000 a year into an Coverdell ESA, and they’re only available for families below a certain income level, depending on your adjusted gross income. Right now, the requirements are an adjusted gross income of $95,000 or less for single taxpayers and $190,000 or less for married taxpayers. If you make more than that, the limits are up to $110,000 for single filers or $220,000 for married couples.
Start a Roth IRA as a College Fund for Kids
But wait, isn’t a Roth IRA for retirement? Typically, yes, but it doesn’t have to be, according to Laurence Namdar, a financial planner and the founder of Asher Levi Financial, a registered investment advisory firm in Holly Hill, Florida, a suburb of Daytona Beach.
“A Roth IRA is an excellent vehicle for many taxpayers to invest after-tax dollars while shielding earnings and future growth from taxes forever, as long as appropriate distributions are made,” Namdar says.
As with any investment, consider the pros and cons carefully – for instance, other relatives can contribute to a 529 but not a Roth IRA. If you have one, you’ll obviously want to discuss this with your financial advisor.
But one big selling point, says Namdar: “With a Roth IRA, should a child decide not to attend college, the parents already have those funds invested for their retirement.”
Put Money Into a Custodial Account
Custodial accounts are savings accounts that come in two varieties: also called UGMAs and UTMAs (Uniform Gift to Minors Act and Uniform Transfers to Minors Act). They hold virtually the same assets, such as cash, stocks and mutual funds, but UTMAs can also hold physical assets like real estate.
There’s no limit in how much money you can put into a UGMA or UTMA, but this option is best with a child whom you believe is responsible. Your child will legally be able to use the money in the account – for college or anything else – when they turn 18.
Invest in Mutual Funds
There’s no limit on what you can invest, and of course, the money doesn’t have to go toward college. But what you earn will be subject to annual income taxes, capital gains will be taxed when shares are sold and the mutual fund’s assets can reduce financial aid eligibility.
Take Out a Permanent Life Insurance Policy
This is a college savings plan strategy typically used by high-net-worth families to provide tax-advantaged savings for multiple goals, including higher education, according to Bryan Bentley, a financial advisor with Talon Wealth Management based out of Roseville, California.
A permanent life insurance policy is a conventional life insurance policy, but some of the money from your premium goes into the death benefit, and some of the money goes into a tax-deferred savings account.
One of the pluses of doing this, Bentley says, is that the money you save “can be accessed at any time for any reason, so it is not limited to college expenses. It provides additional benefits such as a death benefit, and other living benefits, and there is no adverse impact if it is not used for education expenses.”
He adds that the life insurance policy doesn’t count as an asset when you’re applying for financial aid.
Is it a good idea to take out a permanent life insurance policy? It really depends on each family’s financial situation, according to Bentley.
Rafael Rubio, president of Stable Retirement Planners in Southfield, Michigan, agrees that using permanent life insurance to fund a child’s college education may be a great idea.
“Life insurance gives you more flexibility than 529 savings plans,” he says.
Still, there are downsides of using life insurance to pay for college, Rubio says. “The fees inside the policy can eat away the earnings, and it could take a long time for that cash value to surpass the premiums you pay,” he says. “Thus, it might not make sense to use life insurance to fund your child’s college expenses.”
Rubio sees some other downsides. “Also, some life insurance policies are reliant on the market indexes to perform. A bad run of market returns can doom the intended use of the life insurance policy, much like a 529 plan,” he says.
Take Out a Home Equity Loan
Taking out a home equity loan to pay for your child’s education sounds risky, and it can be. It may also work out well.
“This is a common approach, whether intentional or not,” Bentley says. “The equity in a family’s home is often their largest asset, so it is often used to cover college costs,” Bentley says. “Some families will choose to pay down a mortgage instead of creating a separate college savings plan with the intention of tapping the equity if financial aid or scholarships do not materialize.”
As a college fund for kids, it’s not really the best option – especially if you still have years in which you could be saving money for future education costs. But if you haven’t saved enough and are looking for a way to pay for tuition, not to mention room and board, it may work out.
But that’s why you want to start a college fund for your kids early – so you don’t have to take out as many loans. And as with any investment, but especially with college savings plans, it’s always best to begin putting aside money as soon as you can.