Saving for College? Here are 5 Accounts You Can Start Using Now

It’s true what people say about having kids: the days are long, but the years are short. Sometimes our busy, ever-changing lives leave us wondering: “Where did the time go?” When it’s time to send your child off to college, you may feel sentimental, but there’s no need to feel unprepared. With so many options to save for your child’s future, you’ll be able to find the one for you.

Invest in a 529 Plan

When saving for your child’s future, 529 Plans are a popular choice. These savings accounts offer tax advantages similar to a Roth IRA. When your child is ready to go to college, you can make tax-free withdrawals to pay for qualified education expenses.

Benefits

• You can open a 529 plan as soon as your child is born. This allows the money to grow over a longer period of time.
• The funds apply to both undergraduate and graduate programs at any two- or four-year institution.
• They allow up to $300,000 in lifetime contributions.
• If your child doesn’t go to college, you can change the beneficiary.
• Some K–12 expenses may qualify under the 529 plan, such as tuition and fees.

Drawbacks

• Any funds not spent on qualifying expenses are subject to income tax and a 10% tax penalty.
• You are required to report withdrawals on the FAFSA if the account is owned by someone other than the parent. This could negatively impact the student’s eligibility for financial aid.

Consider a Roth IRA

Roth IRAs are typically used for retirement savings, but you can also use them to save for your child’s future. You can’t take distributions on Roth IRAs penalty free before 59½. However, any account open for at least five years can be used for education, so make sure you open the account no later than your child’s 8th grade year.

Benefits

• Distributions are tax free and penalty free as long as they are used for qualifying education expenses.
• After graduation, the account can still be repurposed as your retirement account.
• The value of the retirement account is not included in a FAFSA application.

Drawbacks

• Roth IRAs have annual contribution limits of $6,000. An average year at a university can cost upwards of $20,000. So, it would be difficult to save enough money with a Roth IRA account unless you start early.

• Remember, any withdrawals from a Roth IRA are considered income, which will be reported on a future FAFSA. This might impact your child’s chances for financial aid.

Coverdell ESA

A Coverdell Education Savings Account (ESA) is a great alternative to a 529 plan. It is a tax-deferred trust account with high potential for growth.

Benefits

• Savings can be used for primary and secondary education as well as college.
• There is more flexibility in what is considered a “qualifying expense.” Parents can use the funds to pay for school uniforms, tutoring, and other K–12 programs.

Drawbacks

• Annual contribution limits are set at $2,000 per person, per year.
• You also cannot make contributions after age 18. All funds must be spent before the beneficiary turns 30.
• There are also income limits on who can contribute to a Coverdell ESA account.

Custodial UGMA/UTMA

Custodial accounts are another great way to save for your child’s future. With a Custodial UGMA/UTMA, you have the ability to transfer assets to your minor children and enjoy tax breaks.

Benefits

• When the assets are transferred, a portion of the value of the assets is taxed at the child’s tax rate, and the rest is taxed at the parent’s tax rate.
• Since this is only a transfer of assets, there are no restrictions on how the money should be spent, other than the benefit of the child.
• A custodial account allows any asset (not just cash), such as stocks, bonds, art, and real estate, to be transferred to a minor.

Drawbacks

• Since the assets are owned by the child, parents have less control over how the money is spent.
• These accounts will have to be reported on a FAFSA, so there is a chance for them to negatively impact financial aid.

Savings Bonds

Savings bonds are issued by the US government and can be purchased from a financial broker or directly from the US Treasury. They may be a good option for more conservative investors, at least for a portion of your investment strategy.

Benefits

• Bonds are low-/no-risk investments since they are backed by the federal government.
• If you invest in Series EE or Series I bonds, interest earned is tax free when funds are used for qualified education expenses.

Drawbacks

• Incredibly low rate of return. You’ll need a backup savings plan.

When it comes to financial planning, you’ll also want to consider making sure you have your retirement accounts set up first. A certified financial planner will help you decide which account is the best option when saving for your child’s future. He or she can monitor all of your accounts and suggest any changes needed to secure a bright financial future for you and your family.

Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in Los Altos, California.

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