Saving for their children’s education is a top priority for most parents. With the cost of college tuition steadily rising, the best way is to start saving early. This helps one avoid taking on debts or exhausting their retirement savings. There are several avenues for parents to start saving for their children’s future. But, while choosing the best savings strategy, it is important to set realistic goals based on one’s current financial situation.
1. Setting education savings accounts
This government-sponsored spending account is one of the most common college fund investment strategies that parents opt for. Education savings accounts (ESAs) enable parents to invest up to $2,000 (after tax) per year for their child. This account is tax-advantaged, meaning parents can get tax benefits for college savings while building a fund for their loved ones’ higher education. If a parent starts saving about $2,000 a year when their children are born, by the time they turn 18 and are ready for higher education, the fund will contain a healthy $36,000 that can cover the college tuition fees. On the contrary, if these contributions are channeled towards a good growth stock mutual fund that averages 10-12% annual returns, then this account balance amount can rise to $112,000.
Education savings accounts come with a higher rate of return than regular savings accounts. Furthermore, parents do not need to pay taxes when they withdraw money from such accounts to pay for education expenses. Moreover, ESAs can help cover K-12 private school tuition in addition to college tuition expenses.
2. Investing in a 529 college savings plan
This state-sponsored investment scheme allows parents to invest in certain portfolios, such as mutual funds or exchange-traded funds. Some 529 college savings plans offer certificates of deposit, index funds, and more. Parents can select investments based on their risk tolerance and time horizon. To avoid unnecessary expenses, parents must watch out for investment fees while selecting the plan suited to their specific needs.
This plan was introduced for parents to receive tax-free payments for qualified educational purposes. There are two kinds of 529 college savings plans—prepaid tuition plans and college savings plans. While prepaid tuition plans are less common, they allow parents to save for college tuition at a specific rate for an in-state public educational institution. Prepaid plans are useful in states with excellent public universities, and parents are sure they do not need to send their children to private colleges.
Alternatively, college savings plans act as an investment account for educational savings. In this account, contributions are made after tax, the funds stored within grow tax-free, and eligible tuition expenses (including room and board, computers, books, etc.) remain tax-free.
The biggest benefit of a 529 college savings plan is that, in some states, contributing to a state-sponsored savings plan qualifies investors for a state income tax deduction or rebate. Another major benefit of this plan is that parents can change beneficiaries or transfer funds to an alternate 529 savings plan if the original beneficiary decides not to attend school or does not use all the money accumulated in the account.
3. Applying for government aid
One of the best ways to save for college is to fill out the Free Application for Federal Student Aid (FAFSA) form. Through this form, schools estimate how much money they can offer students through government channels. FAFSA gives students access to federal grants, state aid, school aid, and work-study programs. Several such aids are offered to students based on their academic performance and financial situations, while various others allow them to work part-time while studying.
Applying for government aid is a useful way to avoid dependence on student loans and other means of borrowing that will put a financial strain on learners and their parents in the long run.
4. Putting money in Roth IRAs
Typically used for retirement savings, a Roth IRA—similar to 529 college savings plans and ESAs—is an investment vehicle for parents to cover their child’s college education. The money one puts in a Roth IRA will grow tax-free. When parents withdraw the money later, they will not need to pay additional tax on withdrawal. Parents can contribute up to $7,000 to a Roth IRA every year.
5. Taking out a permanent life insurance policy
High-net-worth families use this strategy to get tax-exempted savings that can be used for multiple goals, including higher education. The premiums of permanent life insurance policies are often on the higher end when compared to a term life policy. A permanent life insurance policy offers more flexibility than a 529 college savings plan, as the policy’s cash value is not restricted to just college tuition expenses.
6. Considering a custodial account
These accounts, typically set up through banks or credit unions, specifically exist to serve the best interests of young learners. The custodial accounts suited best for college savings tend to be established under the UGMA (Uniform Gift to Minors Act) and the UTMA (Uniform Transfer to Minors Act). In such accounts, parents or guardians contribute money to the fund. They can also manage the account, name the beneficiary, and decide when their child can access the funds stored within. Lack of any contribution limits and zero withdrawal penalties are some of the key benefits of setting up a custodial account to cover college expenses.
