College is expensive: $35,720 per student, according to data from educationdata.org.
Many personal finance experts follow the airplane oxygen mask rule: Make sure your own finances are in order before saving for your children. Before you go all in saving for your child’s future college expenses, make sure it isn’t interfering with your own savings, retirement funding, and ability to pay down high-interest debt.
But if you are in a position to save for your child’s future college tuition, there are things you can do now to help your child afford the high cost of college later. And the best way to save for college is choosing a savings plan that works for your financial situation and goals.
How to Save for College
1. Start Early
It’s truly never too early to start saving for your child’s college education.
Just like investing, saving early and often will give you the best results over time. “Start that moment you decide you want to become a parent,” says Leyder Murillo, managing director and financial advisor at Wolfpack Investment Management in Los Angeles. “The time horizon is your friend here because, as the child ages, the investment should appreciate.”
2. Set a Goal for Saving
Decide how much you want to contribute to your child’s education. If your goal is to cover 100% of your child’s college costs, you’ll need to save differently than you would if you are just looking to pay for part of their college costs.
“Maybe you feel it’s appropriate to commit to funding 50%, and letting your kids come up with the rest through part-time work, scholarships and grants, or student loans,” says Eric Roberge, a CFP and founder of Beyond Your Hammock, a wealth management firm in Boston. “This is an individual choice that is up to you and your family, and there’s no wrong answer here.”
The cost of college tuition is increasingly complex, so figuring out how much your child’s tuition will be can be a challenge in itself — even more so if you’re trying to plan for how much college will cost in 10-15 years. Scholarships, federal aid, and what college your child attends will all impact what the final bill will be. The current average cost — $35,720 per student — at least offers a reference point in determining how much you aim to save.
3. Choose a Savings Plan
There are a ton of savings plans to choose from, and it’s important to understand the implications of each, and what it can mean for your child’s future.
When thinking about how much to contribute to whatever plan you choose, review your cash flow to determine “how much you can realistically dedicate to college savings while not disrupting your current lifestyle or saving for other goals,” says AnnaMarie Mock, a wealth advisor at HIGHLAND Financial Advisors in Wayne, New Jersey.
4. Ask for Help
Especially if you’ve started early, don’t be afraid to ask friends and family to contribute to your child’s savings plan in lieu of gifts.
“Instead of asking for toys or material things for a baby shower, birthday, Christmas, baptism, quinceañera, or any celebration, have them contribute” to a college fund, says Murillo.
Murillo recommends putting directions directly on the invitation: “Instead of gifts, consider contributing to (Name)’s college fund. The instructions to contribute are below.” Then include the custodian’s information and any possible forms that need to be filled out by the gift giver.
Some custodians even offer templates for this scenario that you can send out, or ways for people to gift through an online portal.
Best College Savings Plans
There are many different ways you can save for your child’s college costs. Some plans have restrictions and penalties if they are used for non-college costs, while others offer a bit more flexibility. Just like with retirement investing, there are also benefits to a diverse approach to college saving.
Here’s a closer look at some of these most common options:
529 Savings Plan
One of the most well-known college savings plans are 529 accounts. These tax-advantaged plans are offered in nearly every state, though there are slight difference in how they work depending on where you live.
529 plans vary by state. Some states offer a tax credit for contributions made to the plan, and others offer tax deductions. If your state makes contributions to a 529 tax-deductible, this “will typically yield optimal savings,” says Leo Marte, CFP with Abundant Advisors in Huntersville, North Carolina.
And even if your state’s plan offers no extra tax incentive for when you file each year, you are free to shop for other state-sponsored plans that might have better portfolio options or lower costs.
Another type of 529 is a prepaid 529, or a prepaid tuition plan, which allows you to purchase tuition credits at today’s costs in exchange for a guarantee to apply them in the future — regardless of the cost then, says Marte.
Only 18 states currently sponsor prepaid tuition plans, and some require residency in that state. These plans are often designed for an approved list of institutions. While you can usually transfer the credit or be refunded, there may be a penalty.
Prepaid plans can also limit what the credit is used for. While funds from a 529 savings plan can be used for any qualified higher education expense (think tuition, supplies, computers, room and board), a prepaid plan usually only covers tuition.
A Roth IRA is an investment account that lets you contribute up to $6,000 per year provided you don’t exceed certain income limits depending on your filing status. Roth IRAs offer greater flexibility on withdrawing funds, making them ideal for more flexible saving goals.
If your child decides not to go to college, or gets a scholarship and you don’t need all the money you saved, you can leave that money in your Roth and use it for retirement, or even home renovation/repairs. But if you do need to take it out for higher education expenses, it will avoid the IRS’s 10% early withdrawal penalty.
Diversify your college-saving strategy instead of putting every dollar into a 529.
“If 2020 has shown us anything, it’s that the ability to stay flexible and be willing to adjust in a changing world is a huge asset,” says Wakefield Hare, a financial planner with Greater Than Financial in Kansas City. “The Roth IRA allows parents to do that for their kids and what is best for them.”
One downside to choosing a Roth over a 529 is forgoing the state income tax deduction that many states offer with a 529. Using a Roth IRA to pay for your child’s college could also eat into your retirement savings, unless you aren’t counting on your Roth IRA as a primary way to save for retirement.
Education Savings Account (ESA)
An education savings account works similarly to a Roth IRA, and actually used to be called an Education IRA before it was renamed in 2002. ESAs have strict eligibility requirements that make them less useful for some people. You’ll get the most investment options if you make less than $110,00 per year as a single filer, or $220,000 if filing jointly.
You can’t fund an ESA after the beneficiary reaches 18, and the contribution limit is $2,000 per year. If your child doesn’t use the funds for college, the ESA will be distributed to them, not back to you.
But the funds in your ESA will grow federal income tax free and withdrawals should be tax free as well if you meet certain criteria.
Taxable Investment Account
A taxable investment account, or a brokerage account, is like a 401(k) minus the tax benefits. You can purchase mutual funds, index funds, stocks, bonds, and other assets, but you will be required to pay taxes on things like dividends and capital gains.
“Saving to a taxable account is also a really great method for saving by giving flexibility,” says Mohr. “And you can use it how you need to use it, regardless of what happens with the college landscape for your child.”
If you’re thinking of leaving an educational gift to grandkids or relatives in your estate, you can request to pay a portion or the entirety of a tuition bill directly to a university — without being subject to gift tax rules. This will also reduce your taxable estate, says Marte.
College Saving Diversification
While a 529 savings plan is one of the most popular ways to save for college, but there is a case for diversifying how you save for your child’s college. “I typically don’t advise throwing every last dollar you have toward a 529 plan,” says Roberge.
This is because your child might not decide to go to college at all, and you may face penalties trying to withdraw that money for purposes other than higher education expenses.
To guard against that possibility, Roberge recommends taking your college savings goal, maybe that’s $500 per month, and contributing $250 to the 529 but the other $250 to some other form of savings account with more flexibility, like a taxable brokerage investment account.
“The money in the brokerage can be used any time for any purpose, so that provides parents with some flexibility if things don’t work out exactly how they think they will in terms of kids attending college,” says Roberge.
This strategy would also safeguard against over-saving for your child’s tuition if they end up going to a cheaper school than anticipated.