Have you looked at the price of a four-year degree lately? If you choose a private college, over four years you’ll pay almost $130,000 on average for that diploma.
That’s the price of half a dozen cars or perhaps a small house, depending on where in the country you want to live.
No matter how old your kids are — or even if you’re just imaginung becoming a parent at this point — the time to start saving for that big-ticket education is definitely now. In fact, the sooner you start, the longer you’ll have to take advantage of the magic of compound interest as you watch your savings accrue.
So how should you get started? There are several ways to save for college, each with its own advantages and disadvantages.
529 College Savings Plans
A 529 education savings plan is a tax-advantaged investment account that you can use for qualified education expenses. These plans are similar to retirement accounts in that they offer certain tax breaks, but only if you use them for approved education purposes. If you end up pulling the money out for another reason, you’ll pay taxes and a 10 percent penalty.
529 plans are administered by the states, so there are lots of choices available — there’s no rule saying you have to choose the plan that’s run by the state where you live. You may want to, though, since a handful of states offer a break on their state income taxes for contributions to their plans. If this doesn’t apply to your state, it’s best to research plans based on their performance.
- No taxes on your earnings
- Potential for state tax deductions
- Most costs are eligible, including tuition, room and board, books, and supplies
- Because the account is in the parent’s name, you can change beneficiaries to include siblings, grandchildren and even yourself
- High contribution limits: up to $14,000 per year to stay within federal gift tax limits
- As a brokerage account, 529 plans aren’t FDIC-insured, and it’s possible to lose your earnings and even the principal if the market takes a nosedive
- If you run into an emergency and need to withdraw cash for anything other than education expenses, you’ll pay taxes on your earnings plus a 10 percent penalty on your withdrawal
- 529 plans typically offer a few mutual fund options, but you won’t be able to come up with a custom investment plan where you can fine-tune the percentages of stocks, bonds and other investments
- Fewer investment options mean you can’t shop around for lower-fee index funds
Coverdell Education Savings Account
Also known as the Coverdell ESA, this account allows you to pick and choose your investments as you wish, and you can change them as often as you like to rebalance your investment or add new options. This is more like a brokerage account and less like the simplified, limited-choice model of the 529.
Coverdell accounts also allow you to use the funds for K-12 private school expenses. This used to be a differentiator, but the new tax law for 2018 now allows 529 dollars to be used for K-12 expenses as well.