Many parents want to help their children attend college without accruing debt, and they know that it's best to start saving early to achieve this goal. They understand the benefit of a college education not only in terms of personal growth but also in earning potential, career opportunities and financial stability.
However, college expenses have risen considerably over the years, making it difficult for many families to afford without accruing some debt. Tuition and living costs can run over $60,000 for a year at a private college and more than $30,000 per year at a state university.
Fortunately, there are ways to start a college fund that can help you and your child cover tuition. Here's what you can do:
Choose the best college savings option for you
First, it's important to choose the investment vehicle that meets your needs. There are several fund types to choose from, all with their own rules and tax consequences. You can even have more than one account, depending on how your finances change over time.
Below are some college saving products to consider:
- 529 plans: This plan's name comes from an IRS code section specifically allowing adults to save for college in the name of a child. The plan has tax benefits; the investment earnings from the account grow free of federal taxes if used for qualifying college expenses. The person funding the account pays taxes on the money before it’s contributed to the 529 plan. States sponsor 529 plans that may also have tax advantages to state residents. These accounts can be opened to benefit a student who isn't the donor’s child, and unused funds can be designated for another student at a later time.
- Coverdell Education Savings Accounts: The Coverdell educational savings account is a tax-advantaged way to contribute up to $2,000 a year to a child’s account. This account isn't available to everyone because you need to be under a certain income level to contribute. The advantage is that funds grow free of federal taxes. Sometimes there are state tax advantages.
- UGMA accounts: The Uniform Gift to Minors Act is a custodial account, which means your child or the minor for whom you create the account can own investments like stocks and mutual funds. This account gives them the assets but allows the custodian to control them until the minor reaches legal age. This isn't considered a traditional college fund because the money doesn't grow tax free. Also, it counts against the student and parent when applying for college financial aid, thus reducing the amount of financial aid that the school may offer your child.
- IRA accounts: Most people associate an individual retirement account with retirement savings. However, you can also use an IRA for qualified college payments as long as the contributions have been made for at least five years. IRA plans can be either traditional or Roth, the difference being whether you pay taxes on the funds before you put the money into the account. For Roth IRAs, you pay the taxes up front. Any money taken out within the appropriate timeframe is tax free. With a traditional IRA, you must pay taxes on the withdrawn money.
Start saving for your child’s college early
Ideally, the best time to start a college fund is when your child is born. With compound interest and regular investments made monthly or yearly, the funds have an opportunity to grow over a longer period of time, and you don’t need to put aside as much each month or year to reach your savings goal.
Your funding can be modest, and many parents find they can afford $25-$100 from each paycheck, automatically deposited into the college savings plan of their choice. If you get a raise or bonus, that money (or a portion) can also be allocated toward college savings.
Family members can contribute to a child's college savings by opening their own 529 plan accounts. They can also make contributions to an established 529 account under the child's parents' name, if the plan that the parents use accepts third-party contributions.
Some plans don't accept these contributions, in which case it's best to create a new account or gift the parents cash intended for deposit into the 529 plan. Regardless of how the plan is set up, it's important to maintain contribution levels that will ensure you can afford tuition and other costs. Such discipline can be particularly useful if you face additional financial obligations later.
Take time to understand the various rules when deciding which plan to open and how much to contribute. You can use this helpful college savings calculator to get realistic estimates for your finances.
No matter what plan you choose, starting a college savings fund for your child is a big investment. Let a Nationwide financial advisor help guide the process.