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How to Save and Invest for College

Saving for your child’s college education is important, but it can be daunting. We break down how to plan for this crucial step in their life.

Most parents would like their children to go to college. But the fact is that it can be extremely expensive. According to EducationData.org, Americans on average intend to save around $57,981 for their kid’s education. This may sound like a lot, but with a savings and investing plan in place, paying for some or all of your children’s schooling should be an easier goal to reach.

In this article, we’ll explain why early planning is so critical for your children’s financial future. You’ll also learn about the various savings account options you can use, as well as how to invest within them. After reading, you’ll have a better understanding of what it takes to develop an effective education plan for your kids.

Family at a college graduation

Why It’s Important to Develop a Plan

Let’s face it, college is expensive. On average, it’ll cost $104,108 over four years just for one student to attend. With this fact in mind, the importance of planning as a parent is magnified. If a parent doesn’t pay for at least some of a kid’s education, they could end up drowning in student loan debt.

It’s also key to start saving as soon as possible. The sooner you do so, the more you can put away and invest. This is especially true because, with the proper savings vehicles, you’ll gain compound interest as time goes on.

Before you get started, we recommend speaking with a financial advisor. Many don’t end up consulting an expert for education planning, often because it doesn’t cross their minds or they think they can go it alone. But doing this can lead to mistakes, such as overestimating how much to save. A professional can help you with each step to ensure you have the best chance of hitting your goal.

Savings Vehicles for Education Planning

There isn’t just one simple way to save for your children’s college. If you’re putting your money in a basic savings account for this task, you may be doing yourself a disservice. Today, there are several savings accounts you can use to both put money away, as well as grow it over time with the power of investing and compound interest. Each one works a bit differently and comes with its own pros and cons.

Here’s a breakdown of each savings vehicle you can use for education planning:

529 Plan

A 529 plan (or qualified tuition plan) is a tax-advantaged savings account you can use to put money away for various forms of education, as well as the expenses that come along with them. On average, 30% of Americans use this vehicle to save for college. Below is a glance at what one can pay for:

  • K-12 tuition.
  • College tuition, including room and board, books, off-campus rent, and computer software.
  • Repayment of student loans, with a maximum withdrawal of $10,000.
  • Tuition for apprenticeship programs.

When you put money into a 529, you’ll be able to invest in a variety of professionally run mutual funds. However, these are the only options you can choose from. Any earnings in the account are tax-deferred, meaning you won’t have to pay until you make qualified withdrawals. Non-qualified withdrawals (i.e., those not for education purposes) will also incur a 10% penalty.

529 plans are also relatively flexible. Anybody can contribute. And, if you donate $17,000 ($34,000 for couples) or less each year, you won’t be hit with the annual gift tax. The account also allows you to reassign beneficiaries, which can be useful if one child decides against going to college, but another wants to go.

Coverdell Education Savings Account (ESA)

Much like a 529, a Coverdell ESA is a trust you can set up for the sole purpose of paying for qualified education expenses. This refers to tuition and fees for college, elementary, and secondary education. To establish an account, the beneficiary must be younger than 18 years old and it must have the ESA designation at the time of creation.

Like other savings accounts, you can contribute regularly to an ESA. Deposits, however, can only be in cash. And you’ll only be able to contribute $2,000 annually if you file jointly, provided you fall below the modified adjusted gross income (MAGI) limits. If your MAGI is over $190,000 but less than $220,000, the amount you can put in will gradually decrease. However, anything over the latter limit means you can’t make deposits.

Unlike a 529 plan, you’ll have more say in what you can invest in with an ESA. This includes various types of securities, such as:

Once the account’s beneficiary is ready to receive distributions, they can do so tax-free. However, this is only the case if withdrawals are to pay for qualified education expenses. Any amount that’s more than necessary is taxable as ordinary income.

ESAs also force distributions if the beneficiary reaches the age of 30. At this point, they’ll have 30 days to withdraw funds, unless they’re a special needs beneficiary. Whatever comes out during this time is taxable unless it goes toward qualified education expenses.

Roth IRA

A Roth IRA is a tax-advantaged retirement account; however, you can use it to help pay for your kid’s college. Typically, you can only withdraw funds without a 10% penalty once you’re 59.5 years old. But the early withdrawal fee goes away if you’ve had the account for over five years and are taking money out to pay for qualified education expenses.

Like a 529 plan and ESA account, you can invest funds within a Roth IRA. Your options here are wide-ranging, from stocks and bonds to mutual funds and REITs. Once you withdraw, your earnings are tax-free.

In general, you can contribute up to $6,500 per year (or $7,000 if you’re over 50 years old). However, the exact amount varies depending on your MAGI.

Brokerage Account

It’s also possible to use a standard brokerage account to save and invest for college. These allow you to buy assets within them to grow your money over time. However, keep in mind that all earnings are subject to capital gains tax.

Even with the tax implications, it may be worthwhile to use a brokerage account to grow your funds in preparation for your children’s college. However, you may not want to use one as your only way to save, as taxes will eat into what you’ll have.

Certificate of Deposit (CD)

While they may not provide large returns, a CD can be an effective tool to save for college. This is a bank or credit union account that allows you to deposit money for a specific period and receive a fixed interest rate. Typically, these rates are higher than a normal savings account.

CDs can be effective for education planning because they’re relatively safe (up to $250,000 is FDIC insured with most financial institutions) and allow you to know how much you’ll earn throughout their duration. They’re also convenient for education in the short-term, as the time funds must sit in the account typically runs for one to three years.

Despite the benefits, you should also be aware of the downsides. For one, CDs aren’t immune to inflation risks. And, as mentioned, your returns will be smaller than, say, a 529 plan or Roth IRA. Finally, these types of accounts are illiquid because you must wait to withdraw without penalty.

Account TypeProsCons
529 planTax-deferred, flexible contributions, can grow with compound interest, and you’re able to reassign beneficiaries.Investments are limited, can only withdraw for qualified expenses without penalty.
Coverdell ESAEarnings grow tax-free for qualified withdrawals and there are more investment options.Contributions are limited, forced distributions once you’re 30, and contributions aren’t tax-deductible.
Roth IRAEarnings grow tax-free, able to be used for more than college, earns compound interest, and more investment options are available.Contributions are limited and they’re illiquid except for education expenses or once you turn 59.5 years old.
Brokerage accountAble to be used for more than college and more investment options are available.Earnings are taxable.
Certificate of deposit (CD)Earns higher interest than savings accounts and is relatively safe if bank is FDIC insured.Illiquidity. Inflation could reduce purchasing power.

Investing Approach to Take

Perhaps just as important as the financial vehicles you use to plan for college is how you invest your funds. The approach you take depends largely on how long you have, as well as your risk tolerance. For example, if you have 18 or more years until a child goes to college, you’d want to plan out long-term investments. But if you only have a few years, short-term assets and accounts, such as CDs and bonds, may work.

For the most part, however, investing for such an expense requires a long-term, lower-risk approach. Securities like mutual funds and ETFs that provide steady growth can be ideal in this case. For help finding the right investments, we recommend speaking with a financial advisor.

If you need help locating a qualified finance expert, we recommend using a matching tool. After filling out a short quiz about your current situation and goals, it’ll present you with three vetted options near you.

How You Can Save Enough

Saving for college can seem daunting, especially when it’s so expensive. However, there are some practices you can stick to so that you can get closer to reaching your goals. Here’s what you should consider in order to make the process easier:

  • Start early. The earlier you begin saving, the more you’ll be able to put away and invest. You’ll also maximize the impact of compound interest toward growing your savings.
  • Make consistent contributions. It’s key to routinely put money into the account, even if it’s just a little bit each month. This way, you’ll stay on track toward your savings goal and have more to invest.
  • Choose the right financial vehicles. If you put your money into an account like a 529 plan, Roth IRA, or Coverdell ESA, you’ll be able to gain more benefits as you save. This includes more investment options, higher interest rates, and tax advantages.
  • Invest wisely. If your account allows you to invest, it’s important to pick the right assets. Typically, you’ll want to aim for long-term growth rather than risky investments.

Frequently Asked Questions

What happens to a 529 plan if my child doesn’t go to college?

Luckily, you’ll have a few options here. You can use a 529 plan to pay for all types of post-secondary education, such as apprenticeships, two-year degrees, and vocational school. So, if your child foregoes a university for a trade, you can still use the assets for that. You’re also able to designate a new beneficiary, such as another kid, if one child doesn’t plan to go to school.

The only other option is to cash out the account. In this case, you’ll have to pay a 10% penalty and income taxes. Because this can be steep, you may want to bide your time before doing this. Also, if the beneficiary gets a full scholarship, you can cash out the account without penalty.

Can I roll a 529 plan into a Roth IRA?

As of 2023, you can’t roll a 529 plan into a Roth IRA. However, in 2024, you’ll be able to roll over up to a limit of $35,000 to a beneficiary’s Roth if you’ve had the 529 for up to 15 years.

Should I open a Roth IRA or 529 plan for my kid?

Both will have long-term benefits for your child. A Roth IRA is mainly useful for retirement planning, but your kid can use it to pay for qualified education expenses. A 529 plan allows you to contribute and invest in order to pay for various types of post-secondary school, including college.

You can open a 529 plan for your child at any time. However, with a Roth, your kid must have earned income. Provided they meet the income requirements, you may want to open a Roth IRA for them or convince them to do it for themselves.

How much should I have saved up for college once my kids turn 18?

The average cost of four years of college is over $100,000 per student. However, saving this much may be out of reach for some. Most Americans aim to save about half this amount by the time their child turns 18, with the rest being filled in by student loans or scholarships.

Keep in mind that there isn’t a rule to this. If your goal is to save for your children’s college, you should only do what you’re able and comfortable with. The key is having a plan in place before you begin. For this reason, we recommend you sit down with a financial advisor to build an effective saving and investing strategy.