With college tuition costs rising at a rate that exceeds the rate of inflation, it’s never too early to start planning for your child’s future. Here are four of the most common ways that parents choose to save for their children’s educational costs.
A 529 College Savings Account
A 529 plan is considered by many financial advisors to be the smartest way to save for college tuition. These state-sponsored accounts allow parents (and other relatives who wish to contribute) to contribute after-tax money that is then invested in stocks, bonds, and money market funds. This money grows tax-free, and if you end up using money to pay for college tuition and qualified expenses, that money remains tax-free. Most approach a 529 plan by investing larger funds while the child is younger and then becoming more conservative with these funds as the child gets older. You can sometimes even set up a 529 account so that a portion of your paycheck is automatically dropped into the account.
Prepaid Tuition Plan
Another option that many families don’t consider is purchasing prepaid college credits that can later be used at in-state colleges. To do this, you must enroll in a state prepaid tuition plan, which allows you to enjoy the same tax benefits that come along with 529 plans. Every state has a different method for dividing college tuition and fees into sellable chunks, but they all require you to start many years before your child starts college and to pay a premium to cover the cost of projected inflation. If your child ends up attending an out-of-state or private school, it’s possible to either get a refund or to transfer the value of the account. It should be noted that this option is not available in all states.
Coverdell Education Savings Account
A Coverdell education savings account is similar to a 529 college savings account in that contributions to the account grow tax-free, and the money in the account remains tax-free if it is put toward qualified expenses. One advantage of Coverdell accounts is that they expand the definition of “qualified expenses” to include educational expenses from kindergarten onward, such as private school tuition, time with a tutor, and college-preparation courses. The drawback, however, is that there are tighter regulations on how much you can contribute per year and when you can make contributions (until the beneficiary reaches the age of 18).
Roth IRA
Financial advisers warn against dipping into retirement savings in order to pay for college tuition, but if you plan ahead, you can make a Roth IRA account work in your favor to finance your child’s college tuition. Since you can put funds from an IRA account toward educational expenses, many choose to have their IRA accounts double as a supplement to an existing 529 college savings account. You might, for example, have two 529 accounts set up for two of your children and then use your IRA account to supplement for the third child. (If one of the two children with a 529 account has money leftover after college, those extra funds can be transferred to the third child.) It should be noted that IRA accounts typically have lower yearly contribution limits and will limit contributions once funds in the account have reached anywhere between $235,000 to $452,210, depending on the state.