3 Ways to Start Saving for College
Here’s how families can select the right savings plan for their child’s secondary education.
- If saving for secondary education feels intimidating, know that you’re not alone and it doesn’t have to be.
- There are many different ways to save, including Coverdell Education Savings Accounts, 529 plans and UGMA and UTMA accounts.
- Each method has its own benefits and drawbacks, and families don’t have to choose just one method — they can mix and match to fit their needs.
Every parent wants the best for their children, which means laying the groundwork to set them up for success. For many families, this includes sending their children to college or trade school. However, saving for secondary education can feel intimidating. And if you’re not sure how to start, you’re not alone.
It’s easier than you think to start saving for a college education, whether you’re just starting a family or your child is applying in the next couple of years. And you have several options to help each dollar work harder for you.
Read on to learn more about three key ways to prepare for college expenses, plus tips to create a savings plan that works for you.
1. Coverdell Education Savings Accounts (CESAs)
Previously called Education IRAs, CESAs are tax-advantaged trust accounts created by the federal government to help make education more affordable for American families.
Money placed in the account can generate interest and returns tax-free. Withdrawals from the account to pay for qualified educational expenses, like tuition, housing or textbooks, aren’t subject to income tax either, as long as they don’t exceed the account holder's qualified education expenses for the year.
You can also use the money in a CESA to pay for qualified educational expenses throughout K-12 and post-secondary education.
How much can you contribute to a CESA?
Up to $2,000 per year for each beneficiary.
What are the drawbacks of a CESA?
There are a few considerations to keep in mind if you’re saving money in a CESA.
Account holders need to withdraw all funds from the account by age 30, and if your child opts not to go to college, they’ll pay income tax on these distributions. Plus, if your child withdraws more than the amount of their qualified education expenses (in other words, if they’re using the funds for non-qualified expenses), they’ll pay tax on those withdrawals, too.
CESAs also aren’t available to every family. If you’re a single taxpayer earning more than $110,000, or a married taxpayer earning more than $220,000, you may not qualify to open an account.
2. 529 Plans, or Qualified Tuition Programs
A 529 plan, also called a Qualified Tuition Program (QTP), functions similarly to CESAs in that the funds placed into an account can generate interest and returns tax-free, and withdrawals used to cover qualified education expenses aren’t subject to income tax.
There are several key features that make them an attractive option for college savings.
Depending on where you live, you may be able to claim contributions to a 529 plan on your state income tax, which can help lower tax obligations while saving for your child’s future. Beneficiaries can also make tax-free withdrawals at any age as long as the withdrawals are used for qualifying education expenses.
In addition, beneficiaries can roll up to $35,000 in leftover funds over to a Roth individual investment account (IRA) to save for retirement.
Some states also offer access to prepaid tuition plans: A 529 savings plan that allows you to prepay for tuition in installments, “locking in” at today’s tuition rates. However, these plans come with the tradeoff of less flexibility — the savings may only be used for tuition, rather than any qualified education expenses, and may not work at every post-secondary institution.
While there are no annual limits on 529 plan contributions, each state sets a cap on how much you can contribute to the account. In New York, for example, the limit is $520,000 per beneficiary across all 529 plans. Once the account reaches this limit, it can still generate interest and returns, but will no longer be able to accept additional contributions.
What are the drawbacks of a 529 plan?
529 plans offer several significant advantages but there is one downside: Limited flexibility in how you invest the funds in the account. 529 plans are not self-directed investing accounts, so your investment strategy may be limited by the options available in your region.
3. UGMA and UTMA accounts
If you’re looking for a flexible savings account, opening a Uniform Gift to Minors Account (UGMA) or Uniform Transfer to Minors Account (UMTA) may be the right fit for you.
Both accounts are considered custodial accounts: They allow parents or guardians to save and invest on behalf of the child until they become a legal adult, at which point the account is transferred to them.
UGMA and UTMA accounts allow parents to bypass the gift tax when passing wealth down to their child, ensuring that more savings can go to the intended beneficiary.
How much can you contribute to a UGMA or UTMA?
There are no contribution limits on a UGMA or UTMA.
What are the drawbacks of a UGMA or UTMA?
There are potential drawbacks to consider when deciding if this is the right account for you. UGMAs and UTMAs are taxable accounts, which means you — and eventually, your child — will pay taxes on the interest or returns generated by the account.
The child also gains ownership of the assets in the account once they reach the age of majority, at which point they can spend the funds however they wish. As a result, parents should have a strategy to help their child manage the funds in the account once they reach adulthood and communicate openly about their goals for the money.
How to find the right college savings plan for you
Three tips to set your educational savings up for success.
1. Start with a goal that works for you today
Saving for college can feel intimidating, especially if you’re looking a decade or more into the future. To make it feel manageable, set a regular goal that works for your budget — you can always build on your plan as you go.
2. Mix and match college savings accounts
While it may be a good idea to start with one type of college savings account, beneficiaries can hold a CESA, 529 plan and a UGMA/UTMA. So you can adjust your strategy and take advantage of multiple plans as you work toward your goals.
3. Get support from a professional
We understand that finding the right account(s) for your needs and selecting an investment strategy can be daunting. You don’t need to do it alone. A financial professional can walk through your unique financial situation and discuss your goals to help you find an approach that works for you.
Plus, they can work with you to adapt your strategy over the years, so you’ll feel confident in your finances as your child prepares for college.
