Saving money for college is an important priority for our family. I’d love for our kids to attend college debt free and not have to worry about paying off school loans when they graduate, especially since the cost of education isn’t getting any cheaper.
I received some help from my parents and scholarship money for undergraduate studies, but still had some school debt to manage. I added to this debt when I chose to go to graduate school and decided to finance all of it.
The school loans didn’t hit home until I was responsible for making sure the payments found their way into my monthly budget after I had started my first job. At that point, I knew I had some work to do to get them paid off.
Figuring out how to save for your children’s college isn’t exactly easy. There are a lot of options available and how they work and the tax rules behind some of them can be confusing.
I don’t claim to be an expert and know far less than many of you, but I decided to do some research to better understand some of the options that are out there. Overall, I think it’s important to seek help from a CPA and/or financial advisor before making any investment decisions.
The 529 plan is probably the most well-known way of saving for your children’s education expenses. My wife and I have accounts set up through Fidelity for our two children and use the age based portfolios that fidelity offers.
Here are some of the basics you need to know. Learn more by checking out Fidelity’s 529 page.
- 529’s are sponsored by a state or state agency
- Savings can be used at most accredited universities
- Earnings grow federally income tax deferred and may be eligible for state tax deductions
- Distributions for qualified higher education expenses are federal income tax free
- Investment options include age-based and investment portfolios with mutual funds
- Deductions for non – college expenses are subject to federal income taxes and a 10% penalty. This is important to note if your child decides not to attend college!
- Account minimums be can often be started with as little as $25
- 529’s have extremely high contributions limits
- There is low impact on financial aid considerations. Account is considered an asset of the owner
CNNMoney.com offers a number of 529 tips for choosing a plan, including what to do if your child decides not to go to college.
Coverdell Education Savings Accounts
Another way of saving money for college is through the use of a Coverdell Education Savings Account. These accounts can be opened at many financial institutions and have a much smaller contribution limit than 529 plans and can also be used for non-higher education expenses such as elementary and secondary education.
Here are some of the basics you need to know. Check out Fidelity’s comparison page to understand the difference between 529’s and Coverdell Education Accounts.
- Earnings grow tax deferred and distributions are federal income free
- Account minimums vary by institution
- The contribution limit is $2000 per year. Much lower than a 529 plan!
- As with a 529 there is low impact on financial aid. Account is considered asset of the owner
- Important to note that contributions are limited by the income of the owner. You can contribute if Adjusted Gross Income is over $110,000 (for a single filer) or $220,000 (for a joint filer)
- Benefits can be applied to elementary and secondary education expenses as well!
A custodial account provides the ability to invest on behalf of a minor. They are also known as UGMA or UTMA and based on the Uniform Gifts/Transfers to Minors Acts. Essentially they are brokerage accounts with trading, mutual fund and cash management capabilities. Funds in these accounts are irrevocable gifts and may only be used for the benefit of a minor.
Here are some of the basics you need to know. To learn more, visit Fidelity’s Custodial Account page or read my post: 14 Important Things You Need to Know about Custodial Savings Accounts.
- The account is considered the asset of the child so it can impact financial aid
- No contribution limitations by income
- They require $2500 minimum to start (Fidelity)
- Children are free to spend the money however they please when they gain control. They are not restricted to educational expenses such as with the 529 plan.
Savings bonds for children are a very easy way to invest in your child’s college education. You can get started for a small amount. However, unlike the above options they don’t provide the potential for as high of a return on the investment. But overall, they make a nice gift from grandparents to help initiate college savings and can be transferred into a 529 plan later if you desire.
Here are some of the basics. Visit SEC.gov to learn more about savings bonds.
- Issued by the US Treasury
- You can’t lose the principle investment and can get started for very little
- Can give either a series EE or I bond (interest earnings are different by bond)
- You can avoid taxes by redeeming bonds in the same year college expenses are incurred
- Overall disadvantage is a lower rate of return
- Bonds can be redeemed after 12 months
- Can be transferred to 529 plans
Using money from a Roth or traditional IRA is my least favorite option, but it’s an option. IRA’s are meant for retirement savings and it’s generally not a good idea to dip into them for other purposes. There are a plenty of other options out there to save for college. Still, if your education costs qualify, you can use your IRA without facing the well-known 10% penalty. Qualifications include paying higher education expenses for your spouse, children, spouse’s children, foster children, adopted children, or descendants of the aforementioned.
There are many other things to consider here so read further on tapping your IRA and speak to a CPA before taking action.
UPromise, by Sallie Mae, offers another way to save money for college using an online shopping portal. Okay, so this isn’t exactly investing, but it does offer another way to save money for college. You can shop through 600 online stores or UPromise partners that include big names like Target, Wal-Mart and Dell. Cash back rewards are offered from 1% all the way up to 25% of the purchase. You can also get cash back rewards by registering your current credit or debit cards with UPromise and eating out at partner restaurants can earn you 8% cash back!
What can you do with your earnings? According to the UPromise website, you can choose to invest your earnings in a high-yield savings account or tax-deferred 529 plan; use it to pay down a student loan; or request a check that can be used for college or other expenses. Sign up or learn more about UPromise.
As you can see there are a lot of options to consider when saving for your children’s education and it can get confusing when trying to find the best option.
As I mentioned, we started 529 plans for our children through Fidelity. I have an automatic deposit set up each month so it works similar to investing in my 401(k). We also use the age-based investment option which seems to be the easiest from a management standpoint. We’re not contributing as much as we’d like right now, but it’s a start!
Have you started saving for your children’s education? If so, how are you doing it?