In 2017, parent income and savings paid for nearly 23 percent of college costs.1 As education expenses continue to climb, parents are looking for strategic ways to save money for college.
Advantages of saving early
If you can, begin putting away money for a child's education early. This means setting up a savings account that's allocated specifically to education. It may seem like a simple strategy, but it can potentially reduce the amount both you and your children need to borrow for future college expenses. For example, if you were to put away just $200 a month from the day the child is born and earn a 4 percent average return (compounded monthly), you could potentially have as much as $63,000 by the time your child is a college freshman.*
Saving with 529 plans
One savings option to help you strategically set aside money for college is a 529 college saving plan. Named after the IRS code section that created it, a 529 plan is a tax-advantaged investment plan that's designed to encourage saving for future higher education expenses of your beneficiary (typically a child or grandchild).Plans are administered by state agencies and organizations as a way for people to save for qualified educational expenses such as tuition, room and board, and textbooks.
In addition to the 529 Savings Plan, there is the 529 prepaid tuition plan. These plans are not offered in every state and can be more restrictive. They differ from the Savings Plan by allowing you to pre-purchase tuition based on today's rates. This way,you don't have the worry about the rising cost of tuition. However, these types of 529s can lock in the tuition only at schools that are listed on the plan. And although you may be able to transfer the value over to another school (in the event your beneficiary selects a school that is not on the list), there is no guarantee it will cover the full cost of tuition. Also, prepaid plans don't always allow you to use funds for anything other than tuition - they often exclude textbooks, room and board, or other necessities.
All withdrawals from 529 plans for qualified education expenses will remain free from federal income tax. Also, many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses.
Other college savings options
- Coverdell Education Accounts are a flexible way to save tax-free for college and/or kindergarten through 12th grade, allowing you to save up to $2,000 a year per child.
- A Uniform Gifts to Minors Act (UGMA) account is used to invest money given to a child from grandparents or other relatives and family friends.
- The Uniform Transfers to Minors Act (UTMA) is similar to the UGMA, but allows minors to also own other types of property, such as real estate, fine art, patents, and royalties, and to receive the transfers through inheritance.
Both UGMA and UTMA accounts offer the opportunity to reduce income taxes by shifting investment income from a high-income tax bracket to a child's lower bracket.
There are many pieces in the college savings puzzle, and not every plan fits every family. Your particular circumstances will determine what's best for you. For more detailed information on how these different types of plans work, speak with a qualified financial professional.
NOTE: As of 2018, the IRS has amended the term “qualified higher education expense” to include a limited amount of annual expenses from a 529 Plan for tuition at an elementary or secondary public, private, or religious school. Source: www.irs.gov/newsroom/529-plans-questions-and-answers.
*Regular investing does not ensure a profit or protection against loss. Your investment experience will differ from those of others. Returns will be reduced by fees and expenses.