Saving for Your Kid’s College Education? Here Are Some Things to Consider

What we’ll cover:

• Saving for college can feel daunting especially in the face of other financial priorities
• But with a little patience and planning, you got this!
• Your options may include: a 529 college savings plan, Coverdell Education Savings Plan or custodial account (UTMA/UGMA) 
  
• Pay attention to your time horizon and risk tolerance when investing for college

If you’re planning to send your kids to college, it’s never too early to start planning and saving. Higher education comes with a hefty price tag. And the sooner you start, the more you could save. 

When it comes to paying for college, we're not just talking about tuition. The total cost usually includes other expenses like fees, books, transportation, as well as room and board. 

College costs can vary widely depending on the state and the particular school you’re looking at. But to give you an idea, here are the latest numbers from the College Board’s 2021 Trends in College Pricing study.

With these eye-popping numbers, saving for college can be a challenge, especially if you have other financial goals on your “to-do list.” But with a little discipline and patience, you got this!

In this article, we’ll share a few tips that could help you start planning and saving. 

Now if you’ve already started putting some money away (nice!), think of this as a refresher and see if there are any funding options you haven’t considered.

Crunching numbers to figure out costs and how much you need to save can be tough to do on your own. There are various factors you may need to take into consideration, like inflation. Don’t be shy about consulting a financial advisor for help if you need the assist.

If you have specific schools in mind, do some research to see how much you’ll generally need. To help you set a savings target, ask yourself whether you’re planning to cover most of the costs or will you go in half and half with your child? 

Keep in mind that with the help of scholarships and grants, you may not need to cover all of the costs on your own. In 2020-2021, scholarships were used by 56% of families according to Sallie Mae, one of the largest student loan providers in the US. 

But here’s the important thing to remember in all this: Even if you can’t save as much as you want right now, every little bit can help. And down the road, you might be able to increase that amount if your financial situation changes.

And that’s not just some casual pep talk. Think about it this way: If you’re able to fund even a portion of your child’s higher education costs, that’s less money they might have to borrow down the road. (No one wants to be saddled with a big student loan bill after graduation.)

Once you’ve come up with a target amount you want to sock away, consider automating your monthly college savings. Putting it on auto-pilot can help you save consistently and regularly.

Decide which college savings vehicle makes the most sense for you

Once you know how much you want to put away, it’s time to figure out how you might want to save. 

Socking money away in a traditional or high-yield savings account or parking it in a certificate of deposit (CD) account are two ways to save for college. But you may want to consider other options that can help fund your child’s higher education costs. 

1. 529 Plans 

You might already be familiar with 529 accounts, but here’s a quick refresher. 

These plans, sometimes referred to as “qualified tuition programs,” are typically administered by states. There are two types of 529 plans:

• Education Savings Plans: This is a type of account with special tax advantages to help people invest for certain education expenses. The beneficiary of the account can be your kids, yourself or anyone else you’d like to help out. These 529 plans offer a variety of investment options; the details of which will vary state by state. 
• Prepaid Tuition Plans: These plans are less common. As the name implies, they allow you to pay the tuition for certain colleges or universities in advance. This essentially allows you to lock in current tuition rates even though the beneficiary (i.e., the student) may not actually start college for several years. Unlike education savings plans, prepaid tuition plans cannot be used to cover the costs of room and board. They can be sponsored by states or by participating higher education institutions. 

Good to know: States, as well as the District of Columbia, administer their own 529 plans, so plan rules, features and contribution limits will vary state to state. When you’re ready to open an account, you can contact the specific state agency that’s in charge of the 529 plan you’re interested in. (And yes, generally, you can sign up for a 529 plan outside of the state you live in.)

You can also check out the College Savings Plans Network (CSPN). It’s a resource center that provides more specifics about each state’s 529 plan(s). 

Learn more: What Is a 529 Plan?

2. Coverdell Education Savings Account

You can open a Coverdell ESA at a brokerage firm or other financial institutions. 

This is a tax-deferred trust or custodial account that you can set up and manage on behalf of your child (or another designated beneficiary) to help them save for college.

A Coverdell ESA is similar to a 529 plan, given that withdrawals from the account are tax-free if the money is used to pay for qualified education expenses, like tuition and fees.

However, unlike a 529 plan, you can only set up and contribute to a Coverdell ESA if you meet certain income and eligibility rules. Generally, if you’re eligible, you can contribute up to $2,000 annually to a Coverdell ESA per designated beneficiary. (Contributions are not tax deductible.)

Keep in mind that the annual contribution limit is $2,000 for each beneficiary – no matter how many individuals contribute. Contributions can only be made to their ESA up until they reach age 18, unless the beneficiary has special needs.

So what are the income eligibility rules? Bear with us – we’re about to throw some more numbers at you. 

Under IRS rules, you can contribute to a Coverdell ESA if your modified adjusted gross income (MAGI) is less than $110,000 (or $220,000 for joint filers). In other words, if your MAGI is $110,000 or more ($220,000 or more for joint filers), you can’t contribute at all. 

Now if your MAGI falls between $95,000 and $110,000 (between $190,000 and $220,000 for joint filers), the $2,000 contribution limit is gradually reduced. See IRS Publication 970 for more information on how to calculate the reduced limit.

Here’s another key difference between a Coverdell ESA and a 529 plan: Generally speaking, any money left in the Coverdell account when the beneficiary reaches the age of 30 must be distributed within 30 days. (This rule does not apply to a beneficiary with special needs.) 

The earnings you take out will generally be subject to income tax and 10% additional tax at that time – unless you use the distribution to pay for qualified educational expenses for the beneficiary.

Good to know: Before the beneficiary reaches age 30, you may be able to change the account beneficiary to another member of the beneficiary’s family who is younger than age 30. 

You may even be able to roll over the account balance tax-free to another ESA for the benefit of a younger member of the beneficiary’s family. Again, the age limit doesn’t apply if the new member is a special needs beneficiary.

3. Custodial Accounts

You can use a custodial account to set aside money (or other gifts) for your kids. The money could be used for any purpose that benefits your child, like paying for college! Although they’re not tax-deferred accounts, custodial accounts might help you save some money on income taxes (kiddie tax rules may apply). See IRS Publication 929 Tax Rules for Children and Dependents for more information. 

Uniform Gift to Minor Accounts (UGMA) or Uniform Transfer to Minor Accounts (UTMA) are two common types of custodial accounts. And as custodian, you’re in charge of managing the funds in the account until your kid reaches the age of majority. (Usually that’s 18 or 21 depending on the state you live in.) 

Keep in mind that custodial accounts come with certain rules. It’s important to understand how they work before opening an account, so that you can decide if it’s right for you. 

• Contributions to a custodial account are considered an irrevocable gift to the child (in other words, you can’t change your mind and take it back down the road).
• You, as the custodian, can only use the money in the account for the benefit of the child. (Basic parental support such as food, clothing and shelter doesn’t count).
• Depending on the state you live in and how you set up the account, the account legally becomes your child’s property once they reach the age of majority. So it’s possible that while you may have set it up for college, they may have other ideas on how to use the money when they take control of the account!

Good to know: While you’re the custodian, the money in the account actually belongs to your child. Why does this matter? The funds in the custodial account could lead to a reduction in financial aid if your child applies for assistance.

Pay attention to your time horizon and risk tolerance when investing for college

529 accounts, Coverdell ESAs and UGMA/UTMAs come with their own menu of investment options. Depending on the type of account(s) you use, you may have a number of investment choices.

As you review your investment choices within these accounts, there are a few basic points to keep in mind. You know how factors like time horizon and risk tolerance are important when it comes to your retirement investment strategy? Well, they matter when you’re investing for college, too. 

Let’s say you have a younger child who still has a while before heading off to college. You might consider a more aggressive investment portfolio (think: more stocks than bonds). Remember, the longer time horizon means more opportunity for the portfolio to potentially get a higher rate of return and rebound from potential losses. (Investing involves risk, including the potential loss of money invested.)

On the other hand, if your child is nearing college age, consider adjusting your portfolio to hold more stable investments like high-quality short-term bond funds or money market funds. These assets are generally less volatile than stocks. And they could potentially help protect your principal and your earnings. 

Many college savings plans offer age-based fund options that can adjust the portfolio over time as your child gets older. That said, it’s a good idea to remember to review your investments annually to make sure you’re comfortable with the amount of risk you’re taking on. 

Consider other ways to pay for education expenses

If you’re not able to save as much as you’d like to for your kid’s college education, don’t worry. You may have other options. 

Grants and Scholarships 

These are the types of financial aid you don’t have to pay back. (Yes, please!) You can typically apply for federal financial aid starting October 1 of each year by submitting the Free Application for Federal Student Aid or FAFSA. Don’t forget to explore other sources of aid, too! There are various grants and scholarships out there from individual colleges, states and private groups. 

Education Tax Credits 

Here, we’re talking about the American Opportunity Tax Credit and Lifetime Learning Tax Credit. If you’re eligible to claim these credits, they could help with your qualified education expenses . (The IRS has an interactive tool to help you determine your eligibility.)

This is important: You cannot claim both credits for the same student or same expenses in the same year. The credits are also subject to income qualification rules. This means that the credit amount is gradually reduced if your income is over a certain level. Visit the IRS webpage on higher education credits for more information on eligibility and income rules. 

Education Loans 

Loans can be useful, and the interest on them might be tax deductible . You have plenty of options when it comes to education loans, including ones from private lenders or the federal government. Examples include Stafford Loans, Perkins Loans and PLUS Loans. 

A word of caution: Loans may take years to pay back and can affect a student’s lifestyle and goals once they graduate. And some students may find it challenging to repay them. So if you’re considering taking out a loan, consider your options carefully and do your research to help make sure you’re getting the best rate possible.