- A 529 plan gives you a wide variety of college savings options.
- Custodial accounts put no limit on the amount of money that can be deposited.
- In a Roth IRA, educational expenses aren’t subject to the 10% withdrawal fee.
Anyone with young children knows that though they are the true joys of life, they certainly aren’t cheap! - Diapers, food, clothes, toys: kids need them all and despite the many pleasures of parenthood, the day-to-day expenses of a growing family can add up fast.
But if the costs of caring for a toddler seem daunting, the thought of paying for their college education may be just as scary as the idea that one day they’ll actually be old enough to go to college! And though that day may feel like a lifetime away (especially during those sleep-deprived years), starting to save now may be the best thing you can do - for you and your children. Higher education comes with a hefty price tag — the average cost of a year’s tuition and fees at a private college is $47,831 and growing every year. In-state schools, though less expensive, are still averaging almost $24,061 a year.
Saving is never easy, but putting away even small amounts of money now can help make a sizable dent to the college bill in the years to come. There are several options that have been designed specifically for this need.
Invest in a 529 plan
529 plans hold unique advantages. First of all, you get a wide array of investment options. Second, the money you invest grows tax free, which could be a significant advantage if you start investing early. Finally, the more years of tax-free growth in your savings, the better it may be for you. Not surprisingly, more than 12 million families are relying on 529s for their kids college planning.
But if thinking of investing scares you as much as your child having a temper tantrum in a crowded restaurant, don’t fear! Many 529 plans offer the popular age-based option, where you specify what year your child plans to attend college, and your money is invested for you, based on how many years you have to invest. Your investments also typically become increasingly conservative as your child nears college age. This is all done automatically, making it one less thing to worry about. Keep in mind, regardless of your investment decisions you should continue to monitor your investments at least annually to ensure they continue to meet the investment objectives you have for your account.
529s also allow you to switch the funds to different children (and even a spouse) should college plans for the intended child change. This flexibility is great because any 529 money not used for education purposes is subject to both taxes and a 10% penalty.
To help grow your kids’ 529 fund, ask grandparents and other relatives to consider 529 contributions in lieu of gifts. They can choose to either open an account in their name, or leave the direction of investments in your hands by contributing directly to your already established plan.
Start a custodial account
Simply put, a custodial account is a savings account that you open on behalf of your child. There are no limits on how much money you can deposit and other family members can easily contribute as well. Withdrawals can also be made at any time without incurring penalties — though keep in mind that earnings are taxed annually. Custodial accounts are an easy option for saving and can be opened at any bank.
Unlike the 529 plans though, you can’t switch beneficiaries once you’ve set up an account in a child’s name. Also, once your child comes of age (18-21, depending on what state you’re in), you no longer control the money and therefore can’t legally designate it solely for education expenses.
Open a Roth IRA
Did you know that Roth IRAs can also help you save for college? Americans have more than $500 billion saved in Roth IRAs. In addition to letting your potential earnings grow federal tax-free and adding a nice supplement to your 401(k), Roth IRAs can be a beneficial asset in saving for tuition. That’s because education expenses are not subject to the Roth IRAs 10% early withdrawal penalty. So you can use the account as a valuable college savings tool.
Although there are limits to Roth IRA contributions, for example the 2016 maximum is $5,500 per year, if you and your spouse were each to save the maximum $5,500 per year over 18 years, you could accumulate $198,000 in contributions alone. And assuming earnings of 6% a year, that could potentially add up to $445,000 — enough to possibly fund college and a nice retirement nest egg.1
While a Roth IRA can be a great tool for college saving, it is always critical to think about the big picture in terms of savings and financial planning.
What you can do next
Start saving now — no matter how young your child is. It’s never too soon to start planning for your little ones’ college years. You will feel much better knowing that you’ve started to lay the groundwork for their success. There are several easy options available — and figuring out which one works best for you is the first step in planning for your child’s future.
1. The compounding concept is hypothetical and for illustrative purposes only and is not intended to represent performance of any specific investment, which may fluctuate. This example assumes a 6% annual rate of return compounded annually. No taxes are considered in the calculations; generally withdrawals are taxable at ordinary rates. It is possible to lose money by investing in securities.