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Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions.
This week’s episode starts with a discussion of work-from-home burnout along with effective ways to avoid Zoom fatigue, Blursday and living in your sweatpants (not that there’s anything wrong with that).
Then we pivot to this week’s question from Rob in San Francisco. He writes, “Hello, Nerd Hotline. I just recently had my first child and had a question I don't think you guys have covered yet. When and how should I start saving for his college fund? And what are the options available for me to start putting money aside to be able to afford his future college tuition, 529 plans, custodial accounts, etc. Thanks.”
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Many parents will find that state-run are a great way to save for their children’s education. There’s no federal tax deduction for putting money in, but the contributions grow tax-deferred and withdrawals are tax-free when used for qualified education expenses. You don’t have to use , but many states offer a tax break as an added incentive to do so.
Minimum contributions vary by state, but they’re typically not high. Many allow you to start automatic monthly contributions of as little as $15 to $25.
As a parent, you’ll be the owner of the account and name your child as the beneficiary. If your child opts not to go to college, you can change the beneficiary to a relative, such as a sibling, a cousin or even yourself. Or you can withdraw the money and pay income taxes on any earnings, plus a 10% federal penalty.
You’ll choose among a number of investment options. Plans typically have an age-weighted option that does most of the work for you: choosing the investment mix, rebalancing regularly and reducing the risk level as college approaches.
Withdrawals from college savings plans can be used at accredited colleges in any state and in some foreign countries as well. (Another type of 529 plan, the prepaid plan, works slightly differently. With these plans, you’re locking in the current cost of tuition. The account can only be used at certain schools, but the money can typically be transferred or refunded if your child doesn’t go to that school.) Parent-owned college savings plans also get favorable treatment in formulas.
Saving enough to cover 100% of a college education isn’t realistic for most people. Retirement savings needs to be a higher priority, and your child likely will have access to at least some financial aid. Anything you do save, however, can help reduce your child’s future debt.
Other options include regular savings and investment accounts, as well as Roth IRAs. These accounts would offer you more flexibility since there’s no requirement you spend the money on qualified education costs.
are sometimes touted as a good way to save for college, but that isn’t always true. Roths allow you to withdraw contributions tax-free for any purpose, but you would owe income taxes on any earnings withdrawn before you’re 59½. Using the money for higher education avoids the 10% penalty, but not the taxes.
Start saving for college as soon as possible. You probably won’t be able to save 100% of the future cost of education, but anything you do save reduces your child’s future debt.
Consider using a 529 account. These state-administered plans offer tax benefits and typically can be used for a college education in any state.
Know your other options, too. Savings and investment accounts don’t offer the same tax savings, but may provide more flexibility. Roth IRAs allow you to use your contributions