How to Save for College

fortpitt in Investments 18 November, 2021

How to Save for College

For many families, putting a child through college can be a financial burden. Many college students take out loans to pay for higher education, and in some cases, it can take a lifetime to pay it all back. So, how can you help your child save for college? If you do your research, it’s much easier than you may think. Use this guide to start learning how you can save for college.

When Should You Start Saving for College?

While it’s never too early to start saving for college, it’s wise to have a few things sorted out first. While it may feel selfish, take care of your future before saving for your child’s.

To start, create an emergency fund, and keep adding to it. You can tap into these savings if you need to pay hospital bills or fix any home or car damages. At the same time, work on paying off your debt before saving for your child’s college fund. The sooner you pay off your debt, the more you’ll be able to afford to help your child save money.

Before saving for college, the third thing you should invest in is your retirement plan to ensure you’ll be financially stable after you retire. If you feel selfish taking care of yourself first, think about it like this — you can always borrow money for college, but you can’t borrow money for retirement. However, if you have enough money when you retire, you can help your child pay off their loans then.

There’s no wrong way to save for college. You can start whenever you’re ready, but the earlier you start, the greater your chance is to save more. The secret is to remember your needs and future matter, too.

Starting a College Fund

When starting a college fund, you have several options for savings accounts, each of which comes with unique pros and cons. Some have restricted eligibility or limits on how much money you can contribute per year. Understanding how each type of account could help you save is the first step in starting a college fund. Let’s take a closer look at some commonly used college fund options.

Education Savings Account

Education Savings Account

An ESA is like a Roth IRA, except it’s only for education purposes. ESA accounts are beneficial because they grow tax-free. You can withdraw the funds without taxes to pay for college and other education expenses like K-12 private school tuition, vocational school, school supplies, textbooks, or tutoring.

The benefits of an ESA include:

  • The account is tax-deferred.
  • You can transfer it to the beneficiary’s relative who is under age 30.
  • There’s flexibility in terms of where you can spend the money.

The disadvantages include:

  • You can only contribute up to $2,000 a year until the beneficiary turns 18.
  • The beneficiary must use the money in the account by age 30.
  • There are income restrictions on who can contribute to an ESA.

529 Plan

A 529 plan is another way to save money for college with tax benefits. Since states sponsor 529 plans, their structure varies by state. As a result, you can use a plan in a different state than the one you live in, and further, you can apply the plan to a school in a separate state than the one where you opened it. For example, if you live in Pennsylvania, you can contribute to a plan in Montana and apply the funds to a college in Arizona.

Benefits of a 529 plan include:

  • As the owner, you have complete control over the funds so that you can use the money for its intended purpose.
  • There are no income restrictions limiting eligibility.
  • You can contribute higher amounts of money to this account.
  • The money can sit as long as you like — you don’t need to withdraw it by a specific age.

Disadvantages to a 529 plan include:

  • Some 529 plans change your investment options based on your child’s age.
  • There is limited flexibility.
  • A 529 plan can affect how much financial aid your child receives.

Other Options

Outside ESA accounts and 529 plans, you may want to consider other choices. Doing extensive research before investing in anything is essential, as there are many aspects to learn. No single option is the best — it’s all about finding what will work best for you and your family’s needs.

Prepaid 529 Plans

Prepaid 529 Plans

For the most part, prepaid 529 plans follow the same rules and restrictions as a regular 529 account. As the name suggests, prepaid 529 plans allow you to pay in advance for blocks of tuition at a state university. This strategy lets you lock in today’s tuition rates, which could provide you with a significant discount since college tuition rates are subject to increase.

While these plans could save you money, you should read the fine print before choosing a prepaid 529 plan. Prepaid tuition plans can be challenging to understand. They can differ in every state — some may restrict how you can spend the money or have rules regarding your child’s acceptance to the school. A significant disadvantage of prepaid 529 plans is that they’ll often only cover tuition and fees, which means you’d have to pay for room and board.

Roth IRA

While most people use Roth IRA accounts to save for retirement, some financial planners suggest saving college money in these accounts, too. Doing so can be beneficial because the money will grow and is available for tax-free withdrawal. Plus, if your child ends up not needing the funds, they’re still there for you. Understanding how to use Roth IRA funds to pay for higher education expenses is critical.

Unlike the 529 plan, the existence of a Roth IRA account won’t affect your child’s financial aid. However, withdrawing the money can harm the potential for financial aid because it increases your income. If possible, it’s a good idea to wait until your child graduates, then use the Roth IRA contributions to pay off their student debt.

Brokerage Accounts

A brokerage account is a regular investment account that offers much flexibility in saving your money. You can contribute as much money as you’d like, and you can withdraw any amount of money at any time without penalties. Crucially, you can use the money for whatever you want, whenever you need it.

The downfall of brokerage accounts is that they don’t include any tax breaks. Although tax-deferred accounts like the ESA and 529 can provide you with significant savings, you might be losing out on the flexibility of options within brokerage accounts.

Uniform Transfer/Gift to Minors Act

We only recommend UTMA or UGMA plans as a last resort. If you didn’t qualify for any other college savings account, consider a UTMA or UGMA plan. While you’ll set up one of these accounts in your child’s name, you’ll control it until the child is 18 for a UGMA plan or 21 for a UTMA plan. Once your child is old enough, they’ll be able to spend the money however they choose.

You can use these plans to save for college. However, they’re essentially mutual funds and aren’t as effective as the other options. Like the 529 and ESA plans, UTMAs and UGMAs have tax advantages. The most significant downfall of this choice is that there’s no guarantee that the recipient will use the money for college expenses. Because your child is free to use the money for whatever they like, they may decide to use it to pay for something other than college.

7 Additional College Saving Tips

Additional College Saving Tips

Long-term saving for college is more than setting up savings accounts and making contributions. To maximize your child’s education savings, consider these additional tips.

  • Make saving automatic: Once you create or designate an account for college savings, set up your checking account to transfer a specified amount into your college account automatically. Make sure you choose an amount that you can manage without putting yourself in challenging financial straits. Automatic contributions require less thought, and without checking on them every time you contribute, it’ll make the savings seem like they’re growing faster.
  • Apply for scholarships: Scholarships are incredibly beneficial, and you can get them for various reasons. Typically, students who excel in academics, sports, or extracurricular activities can qualify for scholarships. Your child should apply to all scholarships for which they’re eligible. It’s free money that you don’t have to pay back. Even small scholarships can add up and save you money.
  • Apply for financial aid: Another way to receive free money for college is through the Free Application for Federal Student Aid. Schools use this form to determine how much money they can offer in the form of school aid, state aid, work-study positions, and federal grants. FAFSA also provides student loans, so make sure you know what you’re accepting.
  • Take AP classes: Your child can take advanced placement classes in high school. For each AP course exam your child passes, they can earn college credits, which means fewer classes you’ll have to pay for. Some high schools even provide students with the option to take courses from a local community college while they’re in high school, which is another excellent way to earn transferable credits and save money in the future.
  • Get a job: Encourage your child to get a job. Whether it’s a part-time position during the school year or a full-time summer position, working is a great way to earn and save money. A job is also beneficial because your child will gain experience to add to their resume for college applications and future job applications.
  • Open a savings account: As your child earns money, they’ll need a safe place to save it. Help your child set up and contribute to a savings account. Many banks offer accounts designed specifically for students, which are typically more lenient about minimum balance requirements and offer waived fees. Having a savings account can also help teach your child responsibilities and the value of saving.
  • Invite others to help: Another way to add to your college accounts is involving your friends and family. Invite family members to make contributions as a holiday or birthday present. Some accounts, like 529s, include ways to accept contribution gifts or offer account-specific contribution gift cards. Remember that gift contributions can be small amounts, and they’ll still be helpful. Every little bit helps!

College Savings FAQ

If you’re searching for answers to additional questions, consider speaking with an experienced financial advisor.

Should I Save for Retirement or College?

Generally, it’s a good idea to make sure you have yourself taken care of first. Financially taking care of yourself in retirement will lessen the burden on your children. If you have your heart set on saving for both simultaneously, it’s crucial to find a balance between saving for college and saving for retirement. Consider testing the saving rates for each and how you can adjust them to grow both accounts.

How Much Should I Be Saving?

How much money you save will ultimately depend on what you can afford and when you start saving. First, determine what percentage of the cost you want to pay for. You can research the cost of an in-state public college and use that number as a baseline. To start, consider saving one-third of the cost of a public college in your home state. Aim to pay a third out of pocket during your child’s attendance and finance the rest through loans.

Of course, if you want to save more or less, adjust the strategy to work with your goals.

What Happens to a 529 If My Child Does Not Go to College?

If you create a 529 plan for your child and they decide not to go to college, you still have options. The money in this account can sit indefinitely, so there’s no rush to take it out. If your child chooses to go to a trade or vocational school, you can apply money growing in a 529 account to those schools as well. If it turns out your child doesn’t need the money, you can always change the beneficiary to another family member at any time.

What Is the Best Account to Save for College?

The most common accounts used to save for college are ESAs and 529 plans. Ultimately, the best choice will depend on your family’s needs. The most effective way to determine what you need is to meet with a financial advisor.

Talk With an Advisor

Knowing the ins and outs of all your college savings choices can be overwhelming. Talk with a financial advisor at Fort Pitt Capital Group to create a plan to save for college. Our experienced advisors will provide guidance even after your plan is in place. Contact us today to learn how we can help you with your investment goals.

Talk With an Advisor

Join Our Newsletter

Receive updates from our blog, retirement plan industry events & news, media appearances, and the latest on Fort Pitt events.