The 3 Best Ways to Save for College Tuition

Estimated read time: 4 minutes

With college education costs rising each and every year, we as parents are concerned our children will be saddled with debt early in their working lives. The average cost per year of college education in 2017-2018 was more than $34,000. This does not include room and board, books, or any other expenses your child may face.

Parents want to start their children on the right foot and help provide an education that will get them ahead. This means we need to save a lot of money to cover these rising costs.

When you get started there might be a lot of intimidating terminology. Don't let it frustrate you or impact your decision to save for your child's education. Each plan has its own benefits, and some even have tax implications that can help ease the burden. It's all about finding the right plan to fit your needs.

Create a plan

Whether you have one child or many, you'll need to devise a rough estimate of how much money they will need for college. If you are 10-15 years away from using this money, then you will have to estimate how much you will need based on the inflating cost of education.

The reason we need to save in higher return investments is because savings accounts will lose value over time due to inflation and the low percentage interest rates most savings accounts offer these days. The longer the time frame you have for saving, the more you will need, and the riskier you can be with investments.

Shorter term savings should be less risky, and you will have a stronger grasp on actual costs associated with college. It's up to you to decide how much you will save to help your kids through school, so make a plan you can stick to and are comfortable funding.

What is an ESA?

The Coverdell Education Savings Account (ESA) is a tax deferred savings account that was made permanent by the 2012 American Taxpayer Relief Act. Not only can this account be used for college expenses but for all of your child's schooling. This account allows for use of funds during all of the years your child is in school(K-12).

You can contribute up to $2,000 per child under the age of 18, per year, as long as you don't make more than the income caps. The Coverdell ESA also must be set up for the sole benefit of the child, you cannot take the money back for yourself at some point. These stiff limitations may hold you back from choosing this plan.

The ESA plan will make for a great tax deferred savings account for your child's education, just keep in mind it is limited based on your income and how the money can be moved.

What is a 529 Plan?

A 529 Plan, or qualified tuition plan, is a tax deferred plan that incentivises you to save for your child's education by allowing the money to grow tax free within the account. It's similar to the ESa, but it's a little more flexible.

The state in which you reside controls the individual regulations of their 529 Plans. They work like a Roth IRA by allowing after tax funds to grow and then are untaxed upon removal for education expenses.

529 Plans are a little more lenient on beneficiaries, and even the account holder and beneficiary can be the same person. Make sure you look up individual state regulations on how your 529 Plans are regulated.

These plans have looser restrictions on how much can be placed in the accounts as well. You can place up to $14,000 as a single taxpayer per year and avoid any kind of penalties. The negative of 529 Plans is these funds can't be used for anything except college or secondary education costs, and not all of those costs are covered either.

Check with your state to determine if a 529 Plan would be the best option for your child's education savings.

What is a UTMA or UGMA?

Uniform Transfers to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) are trusts that are set up for minors as a custodial account. These accounts allow children to own securities or stocks while under the age of 18. Parents can set these up for any child and are not required to be used on college.

The negative of these types of accounts is they can be taxed to the parent or child depending on how the account was set up. Using an account like this would be good for parents that aren't sure their child will continue their schooling but still want an account that will help with future expenses.

These accounts are very flexible since they aren't required to be used solely for education and don't have any tax benefits. Because of that you should make sure the other two plans don't work for you before choosing this one.

Things to keep in mind

  1. Do not save more than you are comfortable with for your child's education. A lot of these accounts will penalize you for removing the funds and not using them for education.
  2. Have an Emergency Fund set aside so you never have to dip into these education funds at all.
  3. Do not jeopardize your retirement accounts to fund your children's schooling. These plans should be used in addition to what you are already saving.
  4. Always remember that tuition is only one part of the equation. Room and board and books are some of the other expenses to consider.

Easing the burden

The burden of paying for a college education doesn't have to be left upon your children. Using one of the above plans can give them a great head start on life. Picking the plan that works best for your financial situation can be tough, but with a little professional advice you can get there.

Each of these plans has positives and negatives, but all of them allow you to use the market to fund an education. The increased earnings potential of the market means you can outpace inflation and grow the money efficiently.