Right off the bat, bikes are not that expensive. But a college education is. The current annual cost of a 4-year public school for an in-state student is roughly $26,000.1 It was about a third of that 20 years ago.2 So, there’s a pretty fair chance the cost of a college education will rise by the time your kiddos don their high school caps and gowns. That’s why you need a plan. Here are some ideas.
Save Early, Save Often
Like the kid who asks his parents for a new bike and is told to save his allowance, parents who don’t plan ahead to pay for college are in for some disappointment. Saving for something you want (or need) requires patience and discipline.
And just like saving for a bike, the likelihood of successfully paying for your kids’ college education improves with time, especially when it’s funded with regular ongoing contributions.
This is because regular contributions to investments, like mutual funds for example, earn a return. That return also earns a return. Over time, this compounding builds up. More importantly, compounding on your regular contributions could multiply their ultimate value.
Since time is on your side, the earlier you start investing, the better. But you have to be consistent. Treat your college savings accounts like utility bills. Miss a few payments and it could be lights out on college for your kids.
College Savings Plans
So, what vehicles can you use to execute your college savings plan? Some of the most common include:
- 529 College Savings Plans
- Custodial Accounts
- Coverdale Education Savings Accounts (ESAs)
How you might use them will be determined by your unique financial circumstances.
529 College Savings Plans
The 529 plan is the most straightforward vehicle to set money aside for education expenses. Funds inside 529 plan accounts grow tax free, and future withdrawals used to pay qualified education expenses aren’t taxed. Qualified expenses include tuition and fees required for enrollment or attendance.
Contribution limits to 529 plan accounts are typically really high, but they’re also subject to gift tax rules.
Most states offer two distinct types of 529 college savings plans, Prepaid tuition plans and Education savings plans.
Prepaid tuition plans let you buy tuition units today. Then, when your kids attend college in the future, you’ve (well) prepaid, no matter what the price is when they get there. Typically, funds can only be used for tuition at specific in-state schools.
Education savings plans are a lot more flexible. Your kids’ can use the money at any eligible out-of-state or international institution. Money can be used for tuition, fees and expenses. It can even pay elementary or secondary school tuition.
There are two common custodial accounts used to give assets to minors that don’t require a separate trust or guardianship, Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA).
UGMA accounts give assets to the beneficiary at age 18, UTMAs 25. The only things that can go into UGMAs are liquid assets like securities (e.g., mutual funds). You can put just about anything into a UTMA.
Money in both accounts can be used for anything, not just education expenses. So, your kids could end up investing in a bicycle repair shop instead of an undergraduate degree. In the meantime, any income above a really low threshold is taxable at your effective rate.
ESAs have really low contribution limits. But funds in these accounts grow tax free. Like a 529 plan, future withdrawals used to pay qualified education expenses aren’t taxed.
Choose an Appropriate Plan
1 EducationData.org, Average Total Cost of College.