Smart Saving Strategies: A Guide to College Funds for Kids

Planning for a child's future education is a significant undertaking for any parent or guardian. Establishing a college savings plan early can significantly alleviate the financial burden associated with higher education. This article explores various college savings options, offering insights and strategies to help families navigate the complexities of funding their children's educational aspirations.

Understanding the Landscape of College Costs

The cost of college has been steadily increasing, making early planning and saving crucial. The average cost of college in the United States exceeds $38,000 per student per year. Since the cost of college continues to grow, it’s best to aim higher than those numbers and start saving as early as possible.

If inflation keeps up, children born today could end up paying up to four times the current price for tuition. The National Center for Education Statistics reports that the average cost of tuition and fees can range from nearly $10,000 annually for in-state residents at public universities to almost $35,000 per year at private colleges or out of state universities. This figure excludes housing, food, and transportation expenses, further emphasizing the need for comprehensive savings strategies.

Given these rising costs, understanding the various savings options and implementing effective strategies is essential to ensure that families can adequately prepare for their children's future education expenses.

The Power of Early Savings

Starting early is one of the most effective strategies for college savings. According to higher education expert Mark Kantrowitzf, if you begin saving when your child is born, about one-third of your college savings will come from your investments. However, if you start when your child is in high school, only about one-tenth will come from your investments. Each year that passes without saving for college could mean less money when you need it.

Read also: Age-Based College Savings Guide

Even if you haven’t started saving yet, don’t panic. It’s never too late to begin, but you’ll want to strategize accordingly.

Setting Realistic Savings Goals

Calculating how much to save for college can be daunting, but it’s an essential first step. It might be helpful to calculate how much you need to save for your child’s college education. When you look at today’s college costs (the College Board calculator conveniently provides averages for different sectors), and estimate they will rise 3-4% annually for the next 8-10 years, the results look astronomical.

When setting savings goals, it’s important to consider various factors, such as the type of institution your child may attend (public vs. private, in-state vs. out-of-state) and potential scholarships or financial aid. As you set your savings goals, it’s inevitable that you will have to look at your budget and figure out how much you have available to put aside. Don’t have a budget? It’s time to create one. Track spending for a month and find places where you can cut expenses to create savings opportunities. Set limits for discretionary categories and stick to them.

Kantrowitzf contends that if you’re aiming to attend a four-year in-state public college, you might need to save around $300 per month starting at birth (assuming a 3% inflation rate).

Exploring College Savings Options

There are several college savings options available, each with its own advantages and considerations.

529 Savings Plans

529 savings plans are state-sponsored plans specifically designed to help families save for college. A 529 plan is a tax-advantaged savings account specifically designed for college savings. The Texas College Savings Plan is a tax-advantaged 529 college savings plan designed to help families and individuals nationwide save for qualified higher education expenses. With our lower fees and expanded investment options, there may never be a better time than now to enroll in the Texas College Savings Plan.

These plans have a big advantage: Your earnings grow tax-free, and withdrawals won’t be federally taxed if they’re used to pay for college tuition, books, room and board, or other qualified education expenses. Generally, the funds from a 529 can be applied to most accredited colleges and graduate schools, including professional and trade schools. Post-tax dollars are added to the account and the money grows, tax-deferred. The earnings remain tax-free as long as the funds are used for qualified educational expenses at an eligible institution.

529 plans don’t have federal annual contribution limits. But there are overall aggregate limits; generally, a 529 balance should not exceed the expected cost of five years of college expenses. 529 plans also have a limited impact on financial aid eligibility, depending on who owns the account. Anyone can contribute to a child’s 529 plan, including relatives. There are several options for 529 savings plans so compare them closely when you’re shopping for one.

It's simple to change the beneficiary to any immediate family member of the original beneficiary if the original beneficiary decides not to go to college, or gets a full scholarship. And most of these plans make it easy for others to make direct contributions to the account. Saving now will help you to afford what you will be expected to pay later-it’s that simple. As long as you save in the parents’ name (and 529 Plans are considered a parent asset), the impact on your student’s eligibility is minimal. The formula that determines eligibility for aid relies primarily on parent income, and parents are generally shocked at how high that calculated contribution from income is.

529 assets may be used to pay for (i) qualified higher education expenses, (ii) qualified expenses for registered apprenticeship programs, (iii) up to $10,000 per taxable year per beneficiary for tuition expenses ($20,000 for expenses beginning in taxable years after December 31, 2025) in connection with enrollment at a public, private, and religious elementary and secondary educational institution. Although such assets may come from multiple 529 accounts, the $10,000 qualified withdrawal ($20,000 beginning in taxable years after December 31, 2025) limit will be aggregated on a per beneficiary basis. The IRS has not provided guidance to date on the methodology of allocating the $10,000 annual maximum ($20,000 beginning in taxable years after December 31, 2025) among withdrawals from different 529 accounts, (iv) amounts paid as principal or interest on any qualified education loan of a 529 plan designated beneficiary or a sibling of the designated beneficiary. The amount treated as a qualified expense is subject to a lifetime limit of $10,000 per individual. Although the assets may come from multiple 529 accounts, the $10,000 withdrawal limit for qualified educational loans payments will be aggregated on a per individual basis. Any earnings on distributions not used for qualified higher educational expenses or that exceed distribution limits may be taxed as ordinary income and may be subject to a 10% federal tax penalty. Some states do not conform with federal tax law. Please check with your home state to determine if it recognizes the expanded 529 benefits afforded under federal tax law, including distributions for elementary and secondary education expenses, apprenticeship programs, postsecondary credentialing programs, and student loan repayments.

Coverdell Education Savings Account (ESA)

Like a 529 plan, a Coverdell ESA invests your contributions in an array of stocks, bonds and mutual funds. These earnings also grow tax-free. They’re free from federal tax when used for qualified educational expenses and are considered a parental asset when it comes to applying for federal financial aid. But a difference between a 529 plan and an ESA is that ESAs are generally used for kindergarten through high school, though usage and limitation requirements vary by state.

Also known as an Education IRA, this fund allows you to save $2,000 (after taxes) per child, per year. And here’s the best part: it grows tax-free! You’ll also most likely earn a higher rate of return than you would with a regular savings account.

Contribution limits to an ESA ($2,000 per year) are based on income limits and are phased out for taxpayers with an adjusted gross income above a certain level. Once the account beneficiary turns 18, you can no longer contribute to the account, and the account must be fully withdrawn by the time he or she reaches 30 or transferred to another eligible family member.

Uniform Transfer to Minors Act (UTMA)

Essentially, the UTMA is designed to pass a large sum of money, real estate or other inheritance to a minor. Otherwise known as Uniform Transfer/Gift to Minors Act, this option is different because it is not created just for college savings. The account will be set up in your child’s name, but it will be controlled by a custodian, which is usually a parent or grandparent.

When you open a UTMA account, you’re simply holding onto assets as a custodian for a minor child. Once your child reaches adulthood at age 18 or 21, depending on the state, the control of the UTMA account is completely and permanently transferred to them.

A UTMA account does not guarantee that funds will be used for college expenses. Once the beneficiary is of legal age, they can use the funds any way they want. Unlike a 529 plan or an ESA, a UTMA account is not a tax-deferred account. For financial aid purposes, the assets in a UTMA account are the child’s and may affect the amount of financial aid they’re eligible to receive. Essentially, a UTMA account is a way to allow your child to own assets once they reach adulthood.

Roth IRA

Most people associate a Roth IRA with retirement. It’s true that a Roth IRA is a great method to save for retirement, but it can also be a tool to help you pay for your child’s college. Unlike a 529 plan or an ESA, which can only be used to cover qualified education expenses, a Roth IRA can be used for both college expenses and retirement income. This could be beneficial if your child doesn’t go to college. Or, if they receive scholarships that pay for their college education, the funds could still be used for retirement. Deposits into Roth IRAs do not receive a tax deduction; however, they do grow tax deferred.

High-Yield Savings Accounts

Another worthwhile college savings strategy is to open a savings account that earns a lot of interest. Start early to get the most out of compound interest. Shop around for high-yield savings accounts with the best annual percentage yield (APY). Some accounts have APYs above 5%. One perk of these accounts is that they’re not affected by market fluctuations. Remember the interest you earn within high-yield savings accounts is taxed. These accounts are great for saving quickly and being flexible, but they may not grow fast enough to save for college.

Maximizing Savings Through Budgeting and Contributions

Effective budgeting is essential for identifying opportunities to save for college. As you set your savings goals, it’s inevitable that you will have to look at your budget and figure out how much you have available to put aside. Don’t have a budget? It’s time to create one. Track spending for a month and find places where you can cut expenses to create savings opportunities. Set limits for discretionary categories and stick to them.

Another great opportunity for saving is when kids receive cash gifts for birthdays or other holiday celebrations. Rather than allowing your child to spend the whole check, send a portion of it into college savings. And most of these plans make it easy for others to make direct contributions to the account.

Involving Children in the Savings Process

In addition to the one-third rule, getting your kids involved in their own college savings can make a big difference.

Getting a job can be a powerful way for future college students to contribute to their college savings. Part-time work during high school or summer jobs can help build savings over time. Working also teaches important life skills like managing money, time, and responsibility-important skills for college and beyond.

Navigating Financial Aid and Scholarships

Applying for financial aid can make college significantly more affordable. By filling out forms such as the Free Application for Federal Student Aid (FAFSA) and CSS Profile, students can determine whether they qualify for financial aid from many sources, including grants, scholarships, loans, and work-study programs. Financial aid packages often combine federal, state, and school help. This gives students a better idea of how much they need to pay.

Unlike loans, scholarships offer money that doesn’t have to be paid. Some scholarships are based on academic performance or need.

Dual Enrollment Programs

Earning college credits while in high school can help students save on college. Concurrent enrollment programs (sometimes called dual enrollment), which enable high school students to take college courses and earn college credits, can give students a head start on higher education.

Adapting to Changing Circumstances

Life is unpredictable, and circumstances can change. It's important to have a flexible savings plan that can adapt to unexpected events or changes in your child's educational goals. My child has decided not to go to college. What happens to their 529 plan? You have a few options if the child intended to benefit from a 529 savings plan decides not to attend college. You can change the beneficiary to another child or another family member to use for qualified education expenses. You can withdraw the money. However, if you’re not using the money for qualified education expenses, you’ll pay a 10 percent penalty on top of taxes on the gains. You might wish to just wait and see if their decision changes. There is no rush. You can simply let the money sit in the 529 account until you make a decision on how you want to proceed. Thanks to the Secure 2.0 Act, which took effect in January 2024, after 15 years 529 plan funds can be rolled into a Roth IRA for your child, subject to annual contribution limits and an aggregate lifetime limit of $35,000.

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