College can be one of the biggest expenses families face, and the earlier you start planning for it, the better prepared you’ll be.
But figuring out the right way to save?
That’s where things get tricky.
With so many investment options out there, how do you choose the best one for your family’s needs?
Let’s take a deep dive into how to plan for college savings: investment options for parents and make this overwhelming process a bit simpler.
Why College Savings Is Important
The Rising Cost of Higher Education
College tuition isn’t getting any cheaper. According to recent reports, the cost of attending a public university has risen by nearly 8% over the past decade, and private colleges aren’t far behind. Planning for these expenses can feel like trying to scale a mountain without a map.
But here’s the good news: with proper planning and the right investment options, you can make that climb manageable. Saving for college isn’t just about putting money aside—it’s about making your money grow.
The Importance of Starting Early
Ever heard the phrase, “Time is money”? When it comes to college savings, time is your biggest ally. Starting early allows your investments to benefit from compound interest, turning even small contributions into a substantial sum over time.
- Example: If you save $200 a month starting when your child is born, with a 6% return, you could have nearly $80,000 by the time they turn 18. Starting later? You’d have to save significantly more to reach the same goal.
How to Plan for College Savings: Investment Options for Parents
1. 529 College Savings Plans
When people talk about college savings, 529 plans often top the list—and for good reason.
What Is a 529 Plan?
A 529 plan is a tax-advantaged savings account designed specifically for education expenses. These plans are state-sponsored, meaning the rules and benefits vary depending on where you live.
Why Choose a 529 Plan?
- Tax Benefits: Contributions grow tax-deferred, and withdrawals for qualified education expenses are tax-free.
- High Contribution Limits: Unlike other accounts, 529 plans often allow you to save hundreds of thousands of dollars.
- Flexibility: Funds can be used for tuition, fees, room, board, and even K-12 private education in some cases.
Things to Keep in Mind
- Non-qualified withdrawals are subject to taxes and penalties.
- Investment options are typically limited to what your state’s plan offers.
2. Coverdell Education Savings Accounts (ESAs)
What Is a Coverdell ESA?
A Coverdell ESA is another tax-advantaged account for education expenses. While similar to a 529 plan, it comes with a few distinct differences.
Why Consider a Coverdell ESA?
- Flexibility in Investments: Unlike 529 plans, Coverdell ESAs allow you to choose from a wider range of investment options, including stocks and mutual funds.
- Broader Usage: Funds can be used for both K-12 and higher education expenses.
Limitations to Note
- Annual contribution limits are capped at $2,000 per beneficiary.
- There are income restrictions for contributors.
Other College Savings Options to Explore
3. Custodial Accounts (UGMA/UTMA)
What Are Custodial Accounts?
These accounts allow parents to save and invest money on behalf of their children. Once the child reaches the age of majority (typically 18 or 21), the funds are theirs to use—no strings attached.
Why Consider Custodial Accounts?
- Broad Investment Choices: You can invest in a variety of assets, such as stocks, bonds, and mutual funds.
- No Usage Restrictions: Unlike 529 plans, funds can be used for any purpose, not just education.
Potential Drawbacks
- Tax Implications: Unearned income above a certain threshold may be subject to the “kiddie tax.”
- Ownership Transfer: Once the child comes of age, they gain full control of the funds.
4. Roth IRA for College Savings
Using a Roth IRA for Education
While primarily designed for retirement, Roth IRAs can also be a sneaky-good tool for college savings. Contributions can be withdrawn at any time without penalties, and earnings can be withdrawn tax-free for qualified education expenses.
Why Use a Roth IRA?
- Dual Purpose: If your child doesn’t need the funds for college, the money can remain in the account for your retirement.
- Tax Benefits: Like 529 plans, Roth IRAs offer tax-deferred growth and tax-free withdrawals for qualified expenses.
Downsides to Consider
- Annual contribution limits are relatively low ($6,500 as of 2024).
- Withdrawals for education expenses reduce retirement savings.