Did you know the average budget for a full-time undergraduate student ranges from $18,550 to $54,880? Of course, these costs will only continue to increase over the years. As a parent, you could be looking at paying double those amounts by the time your young child heads off to college.
Therefore, it’s best — and rather advantageous — to start saving as early as possible to help pay for or finance your child’s college tuition costs. You also want to start and continue building a nest egg that aligns with your tax obligations, yearly limits, and accessibility goals. Here are some of your best options:
Available in at least two-thirds of the states, starting a 529 plan is arguably the best way to go. It offers a good balance of tax benefits and financial aid advantages. Now, the 529 plans offered by different U.S. states may have slightly varied rules, but you’ll generally be able to deduct the savings from your state income tax.
Better yet, if you’re faced with any unsatisfying restrictions in your state, you can choose to allocate funds to a 529 plan you’ve opened in another state. Some plans will allow annual deposits of up to $16,000, and there is an option for sheltering five years’ worth of deposits at once. What’s more, 529 plans do not impact FAFSA eligibility.
However, any earnings made from the plan are often subject to tax if the money is not spent on qualifying educational expenses. You should also be mindful that your investments will be limited to the plan’s offerings.
Coverdell Education Savings Account
Alternatively, you can set up a Coverdell Education Savings Account (ESA) through your bank or brokerage firm. Coverdell ESAs are favorable taxwise, allowing your savings to grow tax-free — as long as they’re used for educational purposes. Otherwise, you will pay tax and a 10% penalty on earnings. You should also be mindful of the $2,000 limit on annual contributions from all sources, as well as the fact that these contributions must cease once the beneficiary reaches 18 years old.
Custodial accounts are governed under the Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA), which allow you to allocate funds or assets into a trust for your child or grandchild. There are no contribution limits for custodial accounts, but you may incur the gift tax if you deposit more than $16,000 annually as an individual or $32,000 as a couple.
Custodial accounts have two significant disadvantages over 529 plans and Coverdell ESAs. First, they are considered student assets, meaning large balances impact eligibility for financial aid. Additionally, beneficiaries get access to the account at age 18 and can use the money for any purpose.
A Roth IRA is conventionally set up and meant for building a retirement nest egg, allowing you to contribute after-tax dollars and earn tax-free interest. However, you can withdraw your funds and use them for college educational purposes at any point. Additionally, know that FAFSA does not count it as an asset, meaning it won’t impact your student’s loan or your beneficiary’s, but it is considered base-year income. One drawback of a Roth IRA is that you won’t be eligible if you earn more than $144,000 annually.
Start Building Your Child’s College Education Nest Egg Now
How you go about starting and building a nest egg to pay for your child’s college tuition and room and board depends largely on your goals. How much do you wish to contribute every month? Would you like access to the funds for purposes other than higher education? You also want to consider taxes, knowing that tax-exempt options are more strict on how you spend the money.