A Busy Parent’s Guide to Saving for College
If you’re the parent of a baby or toddler, college probably seems a looong way off (heck, you may not have even landed on a preschool yet!). At the same time, as you’ve probably noticed, time with kids zips by at a mind-blowing clip. And, just as your little one seemed to go from crawling to standing to walking in the blink of an eye, the distant future isn’t all that far away. Plus, with college tuitions inching up every year, it’s smart to think about saving now, while you still have years for the money you squirrel away to grow.
But even if you’re sold on the importance of saving now for secondary education…the big question is: What is the best way to save for college? The many college savings plan options today can easily make a mom or dad’s head spin. So, we’re here to help. We’ve looked into a few popular ways to save for college—from 529 plans and Roth IRAs to savings accounts—and unpacked a few of the pros and cons for each, so you can make the decision that’s best for your family.
How to Save for College With a 529 Plan
What is a 529 Plan?
A 529 plan is tax-advantaged savings plan that is used to sock away funds for college…although you can also use the funds for some K-12 educational costs as well. Typically, parents will contribute a set amount of money each month starting when their child is a baby. Over time, that can grow to a nice sum! However, the slight catch to 529 plans is that they must be used on a qualified educational cost—which could be tuition, room and board, books and technology, or possibly costs associated with a trade school. If your child does not pursue higher ed, you don’t lose the money you’ve saved, but you will have to pay a withdrawal penalty.
Pros of using a 529 plan to save for college:
- You don’t pay federal taxes or, depending on what state you live in, state taxes on your earnings.
- You can shop state to state for the best 529 plan for you.
- It is easier now than it used to be to use the funds for K-12 educational costs making this plan slightly more flexible than it once was.
Cons of using a 529 plan to save for college:
- 529 plans tend to have significant upfront costs and carry a required monthly minimal contribution (though these tend to be low, around $15/month or $45/quarter).
- Your child’s need-based aid could potentially be reduced because of having a 529 plan.
- If you don't need to use your 529 savings for educational costs, you will pay a withdrawal penalty.
How to Save for College With a High Yield Savings Account
What is a high-yield savings account?
A high-yield savings account is just like a traditional savings account through a bank, but it has a higher interest rate, usually around 1% or 2%. When money sits in a savings account, it earns interest each month. A high-yield savings account requires little effort and financial know-how compared with other investments…simply plunk in your money, and let it grow.
Pros of using a high-yield savings account for college:
- If you use a FDIC-insured bank then your savings are insured for up to $200,000.
- Accounts are flexible and do not generally incur penalties from things like taking out withdrawals.
- Unlike investment plans, savings accounts are not exposed to stock market risk.
Con of using a high-yield savings account for college:
- While this is a low-risk option, it tends to be lower reward. You won’t earn as much as you would from investing in a 529 plan, making growth slower and lower.
- Interest is subject to taxes as personal income.
- If the account is in the child’s name then it can potentially put a dent in their student aid package by as much of 20% of the award.
How to Save for college With a Roth IRA
What is a Roth IRA?
A Roth IRA is an individual retirement account where you pay taxes on your money going in, so that in the future your withdrawals are tax-free. Some families use Roth IRAs as a way to save for college.
Pros of using a Roth IRA for college:
- Earnings grow tax-free.
- You can withdraw funds anytime and for any reason without paying taxes.
- You don’t have to make a required monthly distribution like you would with other types of plans.
Cons of using a Roth IRA for college:
- Remember, you pay taxes on the money going in so if the tax rate in the future is lower, then you’re not saving as much as you could have with other plans.
- There are limits to contributions, and some high-earning families are ineligible for a Roth.
- You must wait at least five years to make any tax-free withdrawals.
How to Save for College With a Mutual Fund
What is a mutual fund?
A mutual fund is a professionally managed investment portfolio where investors pool their funds to purchase securities.
Pros of using a mutual fund to pay for college:
- Mutual funds are convenient because the average investor can grow their portfolio without the burden of dealing with the complexities involved.
- They are managed by professionals with oversight by the federal government.
- You don’t need a lot of experience in order to invest money in a Mutual Fund.
Cons of using a mutual fund to pay for college:
- The fees can be significant regardless of how well an investment is doing.
- Mutual funds are required to distribute capital gains, which subjects the investor to capital gains taxes.
- You can lose money on an investment and still be required to pay taxes on it.
How to Save for College With US Savings Bond
What is a US savings bond?
U.S. savings bonds are bonds (or debt) offered to US citizens to help fund federal spending. They are a low-risk, government-guaranteed investment.
Pros of using a US savings bond to pay for college:
- Because US savings bonds are government-backed, they are safe and very low risk.
- If you plan to use your bonds for college then you might not be on the hook for paying taxes on any earnings your bonds create.
- They aren’t expensive. You can buy bonds for as a little as $25 or as much as $10,000 in a single year.
Cons of using a US savings bond to pay for college:
- The return is pretty low. If you buy a series EE bond then you could earn as little as a penny a year unless you wait the full maturation period of 20 years and then your bond will be worth twice what you paid.
- Any tax advantages available are income based so if your family makes more than the allowable amount then you might on the hook for taxes related to your bonds.
- If you don’t have 20 years to let your bond mature, then you might not be able to use the funds for college anyway.
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