College Savings Accounts: Find the Right One for You
There are a variety of options for where to save for college, including 529 plans, Roth IRAs and savings bonds.
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College seems a long way off when you bring your new baby home from the hospital, but the far-off nature of higher education shouldn’t move college savings strategies too far down your list of priorities. The good news is that there are several methods that can help you get started saving now, potentially saving your child (and you) from student loan debt down the road.
College savings accounts include:
The average cost of tuition and fees can range from just under $12,000 annually for in-state residents at public universities to more than $43,000 per year at private colleges. Multiply that by four, five or six years and you’re talking about a big number.
Committing to a college savings account early can mean success later, especially if you make contributions over a long period of time. Several types of college savings accounts can help you meet that goal.
529 accounts
A 529 plan is an account in which the investment growth and withdrawals are tax-free if the money is used for qualified education expenses. They come in two flavors: as an investment savings account or a prepaid tuition plan.
529 savings plans
A 529 savings account is the most popular education-specific savings plan. You set aside after-tax contributions that grow tax-free, similar to a Roth IRA but with higher contribution limits.
You can't deduct contributions to a 529 plan on your federal tax return, but some states offer a tax deduction for 529 contributions. Each state sets its own 529 accounts contribution limits; but they are generally extremely high ($200,000+).
Withdrawals can be used for qualified educational expenses, such as tuition, room and board, and books. That doesn’t include general living expenses and buying a car for college. Nonqualified expenditures are taxable — and accrue a 10% penalty.
You can use 529 money at any college for qualified education expenses, not just those in the resident’s home state.
Opening a 529 plan directly through a state’s college savings website can mean lower fees — and you can often choose from age-based investment plans that automatically adjust the investment mix over time as the child gets older.
529 prepaid tuition plans
Prepaid tuition plans allow you to “lock in” tuition costs by paying all or part of the costs in advance. You prepay the cost of attending a particular university — or, in some cases, a group of institutions participating in a particular plan — so you can avoid future tuition hikes. For example, you might pay for eight semesters in today’s dollars; that will allow you eight semesters in the future, even if the costs at that time are higher. Prepaid plans have become harder to find over the years, and some may still operate but are closed to new students.
Pros and cons of 529 plans
High contribution rates, generally with no household income limits or age restrictions.
You can change the beneficiary any time.
Tax-free growth.
If the parent is the account holder, it is a parental asset and has less impact on financial aid.
Strictly for educational expenses.
Stock market exposure might affect returns in a down market. Monitor risk, especially as the beneficiary gets closer to starting college.
UTMA/UGMA custodial accounts
A UTMA or UGMA account is a taxable investment account that an adult controls on behalf of a minor until the child becomes a legal adult. At that point, the child gets control of the account. UTMA stands for Uniform Transfer to Minors Act. UGMA stands for Uniform Gifts to Minors Act.
The custodian manages the account, but only the minor can use it. This could be a big responsibility for the minor to take on when they become an adult, and there is no guardrail to control how they spend the money. There are no use requirements on UTMA/UGMA accounts.
The account and its assets are irrevocable and are property of the minor. A parent cannot withdraw money from an UTMA or UGMA account once the money goes into the account. You cannot change the beneficiary on the account.
The minor is responsible for taxes on investment income the account earns.
The account is the legal property of the child, which may reduce the child’s eligibility for financial aid by 20% of the account asset value.
Flexibility.
Can be cheaper and faster than setting up a trust.
No annual contribution limit.
No control once the child becomes adult.
Contributions are irrevocable; can't change the beneficiary.
Account earnings may be taxable.
Can significantly reduce financial aid eligibility.
Roth IRAs
Using a tax-advantaged Roth IRA as a combination retirement account and educational savings vehicle offers numerous benefits and some flexibility. Your after-tax contributions grow tax free, so you gain maximum growth potential. You can also invest in a virtually unrestricted array of stocks, bonds, mutual funds and exchange-traded funds of your choosing, with or without the aid of an investment advisor. The maximum contribution amount for 2025 is $7,000 for those under 50 and $8,000 for those 50 and older.
Withdrawals from a Roth are allowed penalty-free for qualified education expenses, though they will generally be included as income in determining financial aid eligibility.
You can keep the money if it turns out you don't need it for college.
You can withdraw your contributions any time, tax-free and penalty-free.
Annual contributions are capped.
Only people who earn less than the income cap can contribute to a Roth IRA.
Draining your Roth IRA to pay for college could derail your retirement.
Withdrawals of investment earnings are taxable if you are under 59 1/2 and haven't had the account for at least five years.
Coverdell education savings accounts
Coverdell education savings accounts, or ESAs, are a bit like a 529 with training wheels. Yes, qualified withdrawals are tax-free and, as with a Roth IRA, you can buy a wide variety of investments. But contributions are limited to $2,000 per year, and only until the beneficiary turns 18. There are income limitations, too.
Although potentially meager in their growth potential, ESAs can offer more flexibility than 529 plans. Qualified expenses in Coverdell accounts can include educational expenses throughout the life of your child, from K-12 all the way through grad school.
Wide variety of available investments and tax-free growth.
Beneficiary change rules can vary by custodian (the financial firm hosting the account).
All assets must be distributed to the beneficiary by age 30.
Only people who earn less than the income cap can contribute.
CDs or U.S. savings bonds
For very conservative savers, laddering CDs or savings bonds can be an option, at least for a portion of your savings goal. This can offer some flexibility in terms of cash flow, as the portfolio doesn’t mature all at once at some future date.
Series EE and I bonds both offer tax benefits when used for education expenses.
Investment flexibility.
Tax benefits for EE and I bonds.
No tax benefit for CDs.
Overall low return potential.
Savings accounts
Although savings accounts provide little in the way of growth compared to traditional stock market investments, and inflation can eat away at the account's buying power. However, they do offer flexibility. Tapping the accounts for non-college-related expenses with the hope of replenishing the funds later can result in a depleted college fund.
Investment flexibility.
Few, if any, tax benefits.
Low return.
Saving for college can mean using multiple accounts
Although 529 plans are a tax-efficient, flexible and popular way to save for college, the right answer for you may be a combination of different accounts. Perhaps a 529 and a Roth IRA. Or a Coverdell and a UTMA/UGMA. It all depends on your long-term goals, the number of potential beneficiaries and your particular income and tax situation.
Starting early gives you even more options. And saving for college can be a family affair: Grandparents may be happy to contribute to a college fund, especially given the annual gift tax exclusion.
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