College is a great opportunity for learning and growth, but the rising costs of higher education can be intimidating for parents and aspiring students alike. In the 2018-19 academic year, families spent over $26,000 on college on average, with most of those costs covered by savings or borrowing. Not surprisingly, nearly 8 in 10 parents said that saving for their child’s education is much harder than anticipated.
At the same time, college can be a worthwhile expense for many families. In this survey, 84% of families said they believed college will help their student get a higher paying job. And 7 in 10 students and parents say the price of college is a good value—either appropriately priced, a bargain, or worth every penny.
The good news is, with some foresight and initiative, college can be more affordable for the average student. All it takes is some basic knowledge of the available options and some discipline to keep contributing year over year, and your child can be set up for success.
In a survey by studentloanhero.com, parents said that savings accounts are by far the most common method of saving for college, with 73% using them for their child’s education costs. Other tools parents use include cash (23%), savings bonds (17%) and 529 Plans (16%). Among respondents, 32% plan to take out a personal loan, 21% intend to co-sign a loan in their child’s name, 19% say they will use a credit card, and 17% plan to take out a Parent PLUS loan.
Unfortunately, many parents pick options that aren’t optimal for themselves or their children. In this article, we go over three ideal options you can use to save money to pay for your child’s college education:
If you aren’t sure what a 529 plan is, don’t worry. A recent survey from Edward Jones found that only about 30 percent of American adults were able to correctly identify a 529 plan as “an educational savings plan.” But a 529 plan is possibly the most effective tool available to average Americans to save money for education. A 529 plan is a tax and financial aid benefit plan that allows you to save for educational expenses in the most optimal manner.
Like a Roth IRA, there are no taxes on withdrawals and your money can grow tax free. The withdrawals could traditionally be used for college costs, including tuition, fees, books, room and board. Now, the Tax Cuts and Jobs Act recently expanded the use of 529 accounts so that families with children in private elementary and secondary school can make withdrawals up to $10,000 a year to pay for tuition.
529 plans have several advantages. They come with high contribution limits (as high as $300,000 depending on the state) and will allow you to save as much as you want for your child’s education. You can also switch beneficiaries with some restrictions, which lets you move money for multiple children’s college savings. Finally, 529 plan assets are treated as the parent’s assets during financial aid eligibility calculations, which does not negatively impact the student.
Education Savings Accounts (ESA)
Another vehicle for college savings is called the Coverdell Education Savings Account, or ESA for short.
ESAs were formerly known as education IRAs because their characteristics are similar to Roth IRAs. Parents can make after-tax contributions to an ESA; any capital gains and dividend income grows tax free.
While you are limited to most common investment vehicles in a 529 plan, you can invest in nearly any product you want in an ESA. However, the disadvantage of using an ESA over a 529 plan is that you can only contribute $2,000 annually to an ESA. In fact, some high earners may not be eligible for an ESA at all. Another disadvantage is that in the current policies, the money in an ESA must be used by the beneficiary by age 30.
Another option available to parents of young children are custodial accounts. You can save directly for your child by opening a custodial account in your child’s name. The account will then transfer over to the child after he or she turns 18.
A custodial account is not just designed for educational savings. In a custodial account, you are not limited to using the money for educational needs. There are no restrictions on what the money can be used for once the account has been transferred over to the child. A good reason for this is that it gives the child more options in terms of pursuing their goals: for example, if they want to use the money to start a business or travel before starting college, they can.
In terms of disadvantages, the custodial account is treated as the student’s asset, which means it can cause a substantial decrease in financial aid eligibility. There is also the potential loss of control for the parents after the account has been transferred over.
The truth is that college might still be a very expensive choice for many people despite their best efforts to save. The best thing a parent can do is begin saving as soon as possible and keep contributing on an annual basis. Even if you can manage only to save a small amount each month, you will be better off doing that than doing nothing. 529 accounts, ESAs, and custodial accounts are just some of the many ways parents can save for their children’s education.