College Savings Strategies
When you bring a new baby home from the hospital, college may seem to be a long way away deep into the future. However, that is not a reason to push college savings strategies down your priority list. In this article, we will take a closer look at some of the best college-saving strategies available today.
- How Much Will You Need To Save?
- 1 – 529 College Savings and Prepaid Plans
- 2 – Savings Account
- 3 – Roth IRAs
- 4 – Coverdell Education Savings Account
- 5 – CDs and Savings Bonds
- 6 – Trusts
How Much Will You Need To Save?
Before we take a look at a number of highly popular college saving plans, let’s look at how much you need to accumulate in this plan. For starters, expect costs of post-secondary school to keep increasing so today’s costs are not going to be the target. For an example to work with, let’s say you are attempting to cover annual college costs of $50,000 for a total of four years. Your timeline ends when your child turns 18 years of age so that means by saving $500 a month starting today with an average earning of 5% should get you in the ballpark. Here are a few of the best college savings plans that will help you to reach that goal.
1 – 529 College Savings and Prepaid Plans
The highly popular of the top college savings plans are the so-called 529 plans. A 529 savings account permits investing in mutual funds or exchange-traded funds that carry the same amount of risk or return as other stock-and-bond-based investment accounts. A prepaid tuition plan lets you lock in tuition costs and removes the impact of fees that will just keep growing. There are both advantages and disadvantages of using either of these plans.
– High contribution rates
– Beneficiary flexibility
– Tax-free growth
– If the account is held by a parent, it is considered a parental asset
– It must be used solely for educational purposes
– Stock market exposure can impact the returns of even the best 529 college savings plan
2 – Savings Account
This is a popular choice for over two-thirds of Americans saving money for their child’s education. Although interest rates are very low, these accounts are flexible.
– Investment flexibility
– Low returns that are far below the inflation rate, and few tax benefits
3 – Roth IRAs
There are many benefits and some flexibility in using the tax-advantaged Roth IRA as a combination retirement account and education savings plan.
– If your child ends up with scholarships and does not require a lot of financial assistance, your retirement savings do not get touched and can stay invested
– There are limits on contribution amounts
– You will pay taxes at your ordinary rate if you are under 59.5 years of age or haven’t had the account for more than five years.
4 – Coverdell Education Savings Account
Education Savings Accounts (ESAs) are a lot like 529 plans. Qualified withdrawals are tax-free and you can buy a wide variety of investments. But there are contribution limits of $2,000 per year until the beneficiary turns 18. There are other limits in place as well.
– A lot of different investments are available
– tax-free growth
– Beneficiary changes are more complicated than with a 529 account and vary from financial firm host to another
– assets must all go to the beneficiary by the time they turn 30 years of age
5 – CDs and Savings Bonds
Certificates of Deposit (CDs) and US Savings Bonds are no longer the go-to choice for parents since interest rates have plummeted to new lows. However, for conservative contributors, these are still alternatives worth considering.
– Investment flexibility
– Minimal, if any, tax benefits
– Low returns
6 – Trusts
In the world we lived in before 529s and ESAs, trusts were the most reliable way to save for a child’s college education. They were structured in a way that all assets were transferred to the child’s account and invested on their behalf until they reached the age of somewhere between 18 and 21, depending on the state they lived in. Once the beneficiary became an adult, they could spend the assets on anything.
– Flexibility to use the accounts on more than just school expenses
– Some tax advantages for the donor
– Flexibility to use the account on more than just school expenses
– The beneficiary cannot be changed
Although college savings strategies are typically not on the top of the priority list when a newborn child is born, there is some logic in thinking that far ahead. However, the tax implications and limits vary from one plan to another. This is why it is essential to discuss the best college savings plans with your financial advisor who can find the right fit based on the variables of your income, tax burden, and size of contributions possible.