College planning for parents: how to save for your child’s education
Set aside money today to fund your child’s tuition tomorrow
If you have dependents approaching college age and haven't started saving, it's never too late to begin. You can't make up for lost time or create college savings out of thin air, but you can start setting money aside and look for other ways to keep college costs down.
Unfortunately, you may have a tall hill to climb if you don't anticipate getting much (or any) financial aid. College Board figures show that, for the 2022-23 school year, the average cost of tuition and fees at public, four-year in-state schools came in at $10,950 per year. Meanwhile, the annual tuition cost at public, four-year out-of-state schools came in at $28,240. And let's not forget these figures don't account for the costs of room and board or books and supplies.
This is likely why 30% of adults have said they incurred student loan debt while pursuing higher education — and why the median amount of education debt among those who borrowed for their own school in 2021 fell between $20,000 and $24,999. If you want to limit how much your dependent needs to borrow to earn their degree, the best time to start saving is now.
Key insights
- College planning can be difficult since families don't know what school their dependent will attend, how much it will cost in the future or how much financial aid they'll receive.
- It's smart to start saving amounts you can for college regardless since you won't get a "redo."
- The best accounts for college savings include 529 college savings plans, brokerage accounts and Coverdell education savings accounts.
How much do you need to save for college?
Certified College Financial Consultant Danny Cieniewicz, who’s also a financial advisor at Hyperion Financial, says many questions need answers before you can come up with a figure to save for college. For example, what career path is the child likely to take? Also, what type of financial aid is your family likely to be eligible for?
According to Cieniewicz, in addition to loans, aid can come in the form of scholarships, grants and work-study programs.
The advisor points out that when you consider room and board costs, public colleges and universities can range between $20,000 to $30,000 per year for in-state residents. Meanwhile, elite private schools at full cost can run up to $85,000 per year.
When considering the cost of college, make sure to factor in tuition, room and board, books and other fees.
However, community college is another path to consider if you want to keep costs down while earning a degree. CollegeBoard figures show that tuition and fees at public, two-year in-district schools came in at just $3,860 for the 2022-23 academic year. That means a student could finish an associate's degree for less than $8,000 in total tuition and fees. It's also possible to complete the first two years of college at a two-year school and then transfer to a four-year school to complete a bachelor's degree at a lower total cost.
While any of these figures can seem daunting, Cieniewicz points out that it's rare for families to not get any type of financial aid, whether need-based aid or merit aid. Either way, he suggests using a future value calculator (or compound interest calculator) to calculate:
- How much you currently have saved
- Your start date and end date
- A projected rate of return
- How much you'll be depositing into the account
- How frequently the interest will compound
"These calculations will give you an idea of how much you can project to have once your child is ready to start school," he said.
For example, an individual who begins saving $100 per month for 15 years with an average return of 7% would end up with $31,696. In this case, $18,000 has actually been saved, and the remaining $13,696 in the account is growth.
5 ways to save for college
Planning ahead for college costs can make getting through school much easier in the long run, but where should you actually stash this money away? There are quite a few ways you can save for tuition and fees, as well as room and board, books and supplies. However, the right strategy for you can depend on your current financial situation (how much you can save) and your long-term goals.
- Open a 529 college plan
- Pierre Huguet, who serves as CEO and founder of H&C Education, says families who want to help pay for school should first consider opening a 529 college savings plan to take advantage of tax benefits and ensure savings are used specifically for education expenses. Because each state offers its own 529 plan with varying terms and features, the benefits across these plans aren't quite standard. However, 529 savings plans let families save for higher education with tax advantages. That means money can be invested for the long run, and withdrawals are tax-free, provided the funds are used for eligible college expenses.
Some states also offer tax advantages for contributing to a 529 savings plan in the first place. In Indiana, for example, taxpayers get a 20% tax credit on the first $7,500 they add to a 529 plan each year (which translates to up to $1,500 back from the state annually).
Also, note that if you don't use all the money saved in a 529 plan, new changes brought about in the Secure Act 2.0 make it possible to roll over up to $35,000 of 529 funds into a Roth IRA for the beneficiary (subject to annual contribution limits) provided the 529 plan has been open for at least 15 years. You can also use funds saved in a 529 plan to pay for private K-12 tuition (up to annual limits) and up to $10,000 in student loan debt repayment.
Pros:
- Withdrawals are tax-free if used for higher education expenses
- Invest the underlying funds for long-term growth
- State-based tax advantages that vary
- Multiple ways to use the money
Cons:
- Penalties apply if funds are withdrawn for non-eligible expenses or rollovers
- Fees can apply
- State plans vary dramatically
- Open a brokerage account
- Cieniewicz says that, in addition to suggesting 529 college savings plans, he recommends investing for college in a non-qualified brokerage account in some cases.
"These plans don't offer the tax benefits a 529 does, but can offer some flexibility that you can use for purposes outside of education," he said.
You can open a brokerage account with any reputable firm (think Vanguard or Fidelity), invest money regularly into stocks, bonds, index funds, ETFs, mutual funds and more. Let the money grow until you need it, then sell investments as needed to pay for school. Since income taxes are paid on money in a brokerage account before it's invested, withdrawals from this type of account trigger capital gains taxes instead.
Pros:
- Have total control over your investments
- Money doesn’t need to be used for higher education expenses
- No income limits apply
Cons:
- No upfront tax advantages
- Open a Coverdell Education Savings Account
- A Coverdell Education Savings Account is one set up specifically for higher education expenses for the beneficiary of the account. Total contributions to these accounts can’t exceed $2,000 per year, and contributions aren’t tax deductible or tax-advantaged in any way. However, withdrawals from this type of account to pay for eligible higher education expenses are tax-free for the beneficiary.
Those who open this type of account also have complete freedom over where they invest the underlying funds. This type of plan can also be used in addition to a 529 savings plan and is considered an asset of the parent for the purposes of determining federal financial aid. That said, income caps built on modified adjusted gross income (MAGI) limit who can contribute.
Pros:
- Withdrawals are tax-free if used for higher education expenses
- Invest the underlying funds for long-term growth
Cons:
- Maximum contribution is limited to $2,000 per year
- Income caps limit who can contribute
- Fees can apply
- Contributions can’t be made once the beneficiary turns 18 unless the beneficiary has special needs
- Start a Roth IRA
- Some families also save for college in a retirement account known as a Roth IRA. After-tax dollars fund these accounts, and funds can grow over time on a tax-free basis. Individuals can take tax-free withdrawals once they reach the retirement age of 59 ½ (once the account has been open for at least five years).
What makes these accounts good for college is that you can withdraw contributions (but not earnings) at any time without a penalty. Ultimately, this is why some families use a Roth IRA to save for college — if they wind up not needing the money, they can keep it in the account to continue growing for retirement.
That said, it's worth noting that income caps limit who can contribute to a Roth IRA each contribution year. The Internal Revenue Service (IRS) also limits contributions across all IRA accounts to $6,500 per year in 2023 (or $7,500 per year if you're age 50 and older).
Pros:
- Have total control over your investments
- Money does not need to be used for higher education expenses
Cons:
- No upfront tax advantages
- Income caps limit who can contribute
- Annual contribution limits
- High-yield savings accounts or CDs
- According to Cieniewicz, today's interest rates have even made some savings products a good choice for families saving for higher education.
"With the dawn of recent high-yield savings accounts, parents with children closer to college age who want to be more conservative should consider keeping funds inside those types of accounts," he said.
For example, it's now possible to find high-yield savings accounts and certificates of deposit (CDs) with rates approaching 5%. These rates are attractive for families who don't want to risk losing principal and may only have a few years to save.
Pros:
- Earn a guaranteed fixed return
- Money doesn’t need to be used for higher education expenses
- No income limits or rules apply
Cons:
- No upfront tax advantages
» MORE: Best online savings accounts
Other ways to pay for college
With the high costs of higher education, you may find you haven't saved nearly enough. Fortunately, there are steps you can take to get your dependent through school without a crushing amount of student loan debt. Consider the following options to pay for college:
- Fill out the Free Application for Federal Student Aid (FAFSA): Filling out the FAFSA is the only way to know if you qualify for federal financial aid and some state-based aid. This form must be filled out for each year of higher education for every student, even if you believe you earn too much to qualify for help.
- Start at community college: Huguet suggests cutting higher education costs dramatically by starting college at a two-year school. "Starting at a community college and transferring to a four-year public institution can offer the same diploma at a lower cost by transferring credits," he said.
- Pursue scholarships and grants: Apply for as many scholarships as possible and do some digging to find all the opportunities you may be eligible for. Some of the best places to start searching for scholarships include Fastweb and Scholarships.com.
- Get help from an employer: Huguet says to look for companies out of high school that offer to pay for an online college degree as part of their benefits. "While some of these programs have a limited number of partner schools for which they are applicable, a growing number offer some tuition reimbursement for students attending other universities," he said.
- Work part-time: College students can also work while they pursue their degrees. Use the extra funds to pay for room and board, living expenses, books, supplies and more. Remember that every dollar you come up with as you go is a dollar you don't have to borrow and pay back later.
- Consider private student loans: While federal student loans should be accessed first, private student loan companies offer funding options that can help fill in the gaps. Just remember that private student loans don’t have the same protections and benefits as federal student loans.
» MORE: Government assistance programs: What are your options?
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Frequently asked questions (FAQ)
How much should you save per year for college?
The right amount to save is different for everyone since it depends on the student's future career path, the cost of attendance at the school they're likely to attend, how much financial aid a family will get and more.
Is tuition tax deductible?
The lifetime learning credit makes it possible for some taxpayers to deduct college tuition on their tax returns. This credit can be worth up to $2,000 per year.
Is a 529 plan only for education?
Funds held in a 529 savings plan can be used for eligible higher education expenses, private K-12 tuition (up to annual limits) or up to $10,000 in student loan debt repayment. Up to $35,000 in unused funds can also be rolled over to a Roth IRA for the dependent (terms apply).
Is a custodial account the same as a joint account?
A custodial account is a joint savings account that lets an adult save on behalf of a minor. However, money in a custodial account becomes accessible only to the minor when they reach adulthood, and the money can be used for anything (not just higher education expenses).
Bottom line
Whether you've already begun saving for college or you're just getting started, you now know there are many different ways to begin the process. You can also use several of the college savings strategies we suggested at once. For example, you can save for your dependent in a 529 college savings account, a high-yield savings account and a brokerage account at the same time if you can swing it.
Whatever you decide, you should focus on stashing away what you can, investing wisely for long-term growth and hoping for the best. Those college days will be here before you know it, and having some money saved is a lot better than nothing at all.
- Sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- College Board, "Trends in College Pricing: Highlights." Accessed May 6, 2023.
- Federal Reserve, "Economic Well-Being of U.S. Households (SHED)." Accessed May 6, 2023.
- U.S. Bank, "Using 529 plans for K-12 tuition." Accessed May 6, 2023.
- U.S. Securities and Exchange Commission, "An Introduction to 529 Plans." Accessed May 6, 2023.
- Fidelity, "SECURE 2.0: Rethinking retirement savings." Accessed May 6, 2023.
- Indiana Treasurer of State, "Tax Credit." Accessed May 6, 2023.
- Fidelity, "529 savings plans." Accessed May 6, 2023.
- IRS, "Topic No. 310, Coverdell Education Savings Accounts." Accessed May 6, 2023.
- Hoffman and Company, "Advantages and Disadvantages of Coverdell Education Savings Accounts." Accessed May 6, 2023.
- Vanguard, "Realized capital gains." Accessed May 6, 2023.
- IRS, "Retirement Topics - IRA Contribution Limits." Accessed May 6, 2023.
- Charles Schwab, "Roth IRA Withdrawal Rules." Accessed May 6, 2023.
- Charles Schwab, "Roth IRA." Accessed May 6, 2023.
- Merck Employees Federal Credit Union, "Custodial Accounts." Accessed May 6, 2023.
- U.S. Department of Education, "When it comes to paying for college, career school, or graduate school, federal student loans can offer several advantages over private student loans." Accessed May 6, 2023.
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