Starting a College Fund for Your Kid – Where to Start
As a young parent, it may feel as if you have too many financial priorities and not enough money in the bank. You've had a baby and built a career but you may also be saving for a new home, retirement, paying down credit cards or other debt. Raising children is expensive, and it would be nice to be able to help them with future college costs.
It may seem overwhelming but it's possible to save for college while taking care of your other financial needs. The key is to have a sound strategy.
Start saving for college early
Considering how compound interest works, it makes sense that the more money you put into a college savings plan now, the better the chance you have of that money growing for the future. There isn't a way to guarantee what growth you'll get from these college savings plans, but with some knowledge you can make the best choice for your situation.
Types of college savings plans
There are specific college savings accounts beneficial for families, depending on your needs. They include:
529 plans/ qualified tuition plans: The name of this plan refers to a section of the IRS code that allows you to save for college with special tax benefits; you don’t pay taxes on the earnings when you use the funds for qualified college expenses. There are two types of 529 plans: prepaid and savings. Prepaid plans allow you to purchase tuition credits at a current rate, and their future value depends on tuition inflation. In contrast, savings plans’ values are based on market performance of whatever your 529 plan money is invested in — a mutual fund is typically the underlying investment vehicle.
Each state is allowed to set up one or more 529 plans. Some states offer tax deductions to residents who open and use that state's college plan. In addition, some private colleges and universities also sponsor prepaid tuition plans.
Coverdell Education Savings Accounts: This tax-advantaged education savings account lets you contribute up to $2,000 per year to your child’s account, if your annual income is within the specified range. The money and interest earned is free from federal taxes and may have some state tax advantages, depending on the plan.
Uniform Gift to Minors Act (UGMA) accounts: A UGMA account is a way your child can own investments, including stocks and mutual funds, when they may not be legally old enough to own those investments on their own. This money does not grow tax free — amounts above $14,000 (or $28,000 for a married couple filing jointly) annually are subject to the federal gift tax, and earnings are taxed at the child’s rate, not the parents’.
Also, if you apply for college financial aid, this money can have a negative impact on the amount of financial aid your child receives. It's important to note that this money belongs to your child, the beneficiary. You may use it on their behalf until they reach adulthood, but once your child turns 18, they can use the assets however they wish - they aren't required to use the money to pay tuition.
There are many things to consider with each account type; specific details on how much money you can contribute, who can contribute, who owns the account and other tax consequences. A financial advisor can help you choose the best college savings plan for you.
How to save for college
Even when money is tight, you can still put funds away into your child's account. By setting up an automatic payment plan, you won't have to think about investing, and you won't be tempted to use the money for something else. Choose an amount to invest each period, even if it's a small amount. If you get a raise, consider increasing your investment amount. Same with a bonus - put a percentage of your bonus into the college account, just as you may want to add more to your retirement plan or other savings and investing priorities.
If grandparents or other family members want to give your children monetary gifts, you can ask them to either start a college savings plan or give you the money to contribute to existing accounts. That's a great way to increase the savings while your family knows they're helping with your child's future.
When you see what your options are and have a plan in place, saving for college can feel much more like an attainable goal. Anything you save now will be helpful for their future. Try our college savings calculator to help structure your savings plan.