The Ultimate Guide to College Savings Plans
As a parent, you know you should be saving for your child’s college education if at all possible. Saving for college makes it more likely that your child will attend—even if you’re only saving small amounts—and the costs of school are skyrocketing. By the time your child is eighteen, there’s no telling how high tuition will be.
But how do you go from knowing you need to save money to actually saving it? Here are four vehicles you can use to build your savings as your child grows.
College Savings Plans
529 accounts allow you to invest money for your child’s education. Some states do not tax the money you put in, and withdrawals are not taxed as long as you use the money for qualified educational expenses.
They are run at the state level, and you don’t necessarily have to live in a state to use its plan. There are two basic types of 529 accounts: college savings plans and prepaid tuition plans.
College Savings Plans
If you’re thinking about opening an out-of-state plan, or you’re not 100% sure if your child will want to go to an in-state college, you’ll likely want to look at a college savings plan. These plans invest your money in the market, and most of them get progressively more conservative as your child nears college age—protecting your investments to a certain degree.
These plans are beneficial because they can usually be used nationwide, and you can use any money saved for costs beyond tuition like books, room and board, and other college-related expenses. Additionally, the new tax bill allows parents to withdraw $10,000/year for K-12 expenses without incurring taxes.
PrePaid Tuition Plans
If you’re purchasing a prepaid tuition plan, you’re likely doing it in your state of residence. Generally speaking, these plans allow you to purchase a certain amount of credit hours at today’s tuition rates, but your child will be able to use them in the future—even if tuition has gone up.
So if one credit hour at a state school today costs $750, you can purchase it at $750. Then, when your child goes to school ten years later, they won’t have to pay any money, even though credit hours may have gone up to $1,300 per hour.
Before opening a prepaid tuition plan, remember that your child will likely be limited to in-state schools. These plans also come with time tables for when you can buy credit hours and at this year’s price point, and some may have age or grade level limits.
Coverdell Educational Savings Accounts (ESAs)
Coverdell ESAs are another tax-advantaged way to invest in the market for your child’s education. However, while there are no hard and fast federal limits on how much you can contribute to a 529, you can only commit $2,000/year to a Coverdell ESA. It also comes with income limits; if your modified adjusted gross income on your taxes is $110,000 or more—or $220,000 or more for married couples filing jointly—you cannot open this type of account.
Coverdell ESAs tend to come with more investment options and sometimes have lower fees than 529s, however. This money can be used for K-12 educational expenses, as well, without incurring tax upon withdrawal.
If you have a child with a disability, you can open an ABLE account for them. These accounts shelter your money from asset tests, and allow you to spend it flexibly.
Maybe you don’t know if your child is going to go to college or not, but you want to save for them regardless. The money in an ABLE account can be used for college, but qualified expenses also include an array of things your child may need—from medical expenses to rent money. That means that even if college isn’t a path they want to pursue, the money you’ve saved will still serve them well in adulthood.
Maximum yearly contributions are $15,000.
Educational Savings Bonds
Millennials probably remember their parents or grandparents buying them EE series savings bonds. These bonds are not taxed when you use them—as long as you are using them for educational expenses.
EE series savings bonds are a very safe investment, but they’re not going to get you a high return. For example, if you purchased an educational savings bond today, it would only earn 0.10% interest for the first twenty years. During this time frame, the Treasury will decide the rate for the last ten years of its life before maturity.
You can get a high-yield savings account that offers an interest rate north of 1.00% these days. Neither rate of return is good, but educational savings bonds are the less ideal of the two.
Which plan is right for me?
Educational savings bonds are not right for anyone at the current moment as there are far more lucrative ways to save money for higher education.
If you have a disabled child and don’t plan on contributing more than $15,000/year, an ABLE account is likely the best bet for you.
If you don’t plan on socking away more than $2,000/year, Coverdell ESAs are attractive with their lower fees and wider array of investment options.
If you’re confident your child will go to school in state, a prepaid 529 account can be a great way to go. For parents who aren’t willing to take the gamble with their child’s future college attendance decision, college savings plans offer great flexibility with a ton of tax benefits.
It’s wise to sit down with a financial professional before making your final decision. They can take a holistic look at your entire investment portfolio and financial situation, and give customized advice. Now that you’ve done a little research, though, you’ll know what they’re talking about when you go in to meet them, and can start making strides toward the plan that’s right for your family.