College is a major expense for many households . In 2021, the average four-year public college tuition cost more than $22,000 per year for out-of-state students. So even if you just finished decorating the nursery, it’s a good time to start a college fund for your child. Oh, and to the parents of teens: it’s never too late, either.
What’s the best way to save for college?
There’s no one right way to start saving for college. But one popular way is with a 529 plan.
What’s a 529 plan?
It’s a savings plan that you (or anyone else) can use to put money aside to cover school costs for the beneficiary. Hint: that's whoever gets to use the money. With 529s, it can be anyone in your family, and you can easily switch it from kid to kid or to another family member, even you.
Another 529 feature: They're sponsored by state governments. But you don't have to be a resident to start investing. You can open a 529 in any state. And minimum investments can vary from state to state. So don’t shy away from exploring your options.
What makes 529s so popular?
529s have major tax advantages. Contributions aren’t deductible. But the federal gov and most states offer tax-free withdrawals. As long as the money is used for qualified educational purposes, which includes housing (even if it’s off-campus), food, books, and school supplies.
And 529s aren’t just for college costs. You can also use up to $10,000 a year in funds to cover K-12 expenses.
What's another way to save for college?
Here are two:
They aren’t just for retirement. They can also be used to start a college fund. The downside? Withdrawals count as parent income. Which could lower your kid’s college aid.
Custodial, aka UTMA or UGMA, Accounts
You can choose from two types of custodial accounts: a UTMA (stands for Uniform Transfers to Minors Act) or UGMA (Uniform Gifts to Minors Act). Both can hold assets like stocks and mutual funds. UTMAs can also hold non-traditional assets like real estate and art.
One thing that may concern parents about these accounts: Once your child turns 18 or 21 (your state decides the "age of majority"), they’ll have unlimited access to that money. And sometimes newly minted adults aren’t the most financially responsible.
Do these accounts have tax advantages for school costs too?
If you've had your account for at least five years, Roth IRAs waive the normal 10% penalty for tapping it before retirement age (psst…the IRS says that's 59½), if you make a withdrawal to cover qualified educational costs.
With custodial accounts, potential tax advantages are complicated and minimal.
How do I choose which type of college fund is best for me?
Think about what’s most important to you when it comes to saving for college. A 529 might be best if you're sure you'll use the money for college. But not if flexibility is your top priority. Remember, 529 money used for anything besides qualified educational costs are subject to a 10% penalty. If there’s a chance you’ll want to spend your savings on other things, a custodial account might be your best bet.
Ok. So how much money do I need to save for college?
It depends. Experts suggest the one-third rule as a guide: Assume that you'll cover a third of college costs with your income, another third with savings or investments, and another by student loans. With that formula in mind, decide how much you plan on contributing. Then calculate how much you’ll need to set aside monthly to reach that amount by the time school starts. Finally, your kid just has to get into college.
College costs aren’t dropping, so your best bet is to start saving as soon as possible. How much you need to save will vary. But planning to save and invest enough to cover a third of your child’s expected college costs is a good rule of thumb to get you started.
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