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A college education can be a path to finding a decent paying job. The National Association of Colleges and Employers reports that the average salary of a 2017 Bachelor’s degree recipient is more than $50,000. But many students are burdened by debt upon graduation. Estimates vary, but the latest figures, referenced in The Wall Street Journal, calculate that graduating seniors have approximately $29,000-$37,000 worth of debt upon leaving college. Planning on both the part of the student and the parent is vital for the path to a college education. The goal here is to help you find the best way to save for college.

Why It Is Important to Save for College

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According to Sallie Mae’s 2018 statistics, six in ten parents are currently saving for their child’s college education. The amount parents are saving has been steadily increasing over the past few years, but most parents report a savings of around $18,000. This is not enough to cover one year’s tuition, room, and board at an in-state institution, which is approximately $21,000.

Parents Must First Meet Their Own Goals

Many financial advisors recommend that parents get their own finances stable before they can find the best way to save for college for their children. Grants and scholarships are available for a college education, so parents need to take care of their financial needs, too. Parents should pay off debt such as their own student loans and credit cards. They should have an emergency fund that’s enough to cover at least 3 months’ worth of expenses. Finally, they should be saving for retirement through a 401(k) or Roth IRA.

The Best Way to Save for College

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With that being said, it may never be the “right” time to begin saving for your child’s education. It is important to begin saving for your child as soon as you can. Putting away a little each month beginning when a child is born is easier for most people than coming up with a lump sum of cash when the child is ready to start their first semester of college. Here are a few options available for the best way to save for college.

ESA

An ESA is an Education Savings Account. It allows you to save $2,000 per year, after taxes, for each child. The rate of return is likely higher than a regular savings account. In addition, there is no tax on the money when you spend it on education.

Advantages

  • Tax-free
  • Numerous investment options
  • Counted as a parent asset when a child is applying for federal student aid

Disadvantages

  • Limited to $2,000 per year per child
  • Income limits apply to investors
  • Money must be invested by the time the child is 18 and used by the time the child is 30 years old

529 Plan

A 529 plan allows investment in stocks and bonds and a withdrawal of the funds for qualifying education expenses tax-free. A 529 plan has more options than an ESA, so it is important that you choose the right plan for you. Select a 529 plan that allows you to choose the funds in which to invest. Steer away from plans that limit your options such as those that invest funds automatically based on your child’s age. Also, choose a plan that allows you to change the beneficiary to another family member. That way, if one child decides not to go to college, then you can choose to use the fund for another child.

Advantages

  • Tax benefits
  • High contribution rates (this differs according to state, but is usually up to $300,000)
  • Limited income and age limits
  • Counts as a parental asset when students apply for federal student aid

Disadvantages

  • Tax and penalty apply if not spent on qualifying educational costs
  • Conditions apply if the plan is transferred to another beneficiary
  • Limited investment options

Prepaid Tuition Plans

A prepaid tuition plan allows a parent to prepay for tuition at an in-state public university at a set price. This is an alternative to a traditional 529 plan.

Advantages

  • Tax benefits
  • Not subject to stock market volatility
  • Can change the beneficiary of funds

Disadvantages

  • The child will not get full plan value if they choose to go out of state for higher education
  • The penalty of 10% plus income tax must be paid if used for fees other than tuition

UTMA/UGMA

UTMA stands for Uniform Transfer to Minors Act, while UGMA stands for Uniform Gift to Minors Act. These funds can be used for education or other purposes. The account is in the child’s name but is managed by a custodian until the age of 21 for the UTMA or 18 for the UGMA.

Advantages

  • Tax benefits
  • Funds can be used for education or other purposes
  • No limits on investment

Disadvantages

  • The beneficiary must remain the same for the life of the fund
  • A child can use the funds how they see fit once they reach the age of benefit
  • Earnings could be subject to tax at the child’s rate
  • Custodial accounts can be counted as a student asset and could reduce student’s federal financial aid

Mutual Funds

Mutual funds are investments funded by a group of shareholders and managed professionally. There is no limit on the amount to invest. The money is not designated strictly for education and can be used at the discretion of the investor.

Advantages

  • Funds can be used for education or other purposes
  • No limits on investment

Disadvantages

  • Subject to annual income taxes
  • Capital gains taxes apply when shares are sold
  • Can reduce student’s federal financial aid eligibility (the penalty is greater if the funds are owned by the student rather than the parent)

Select U.S. Savings Bonds

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Savings bonds are purchased by the public at a discount to their face values. At their maturity, they are worth more than the purchase price. Series EE bonds accrue interest at a fixed monthly rate while Series I bonds pay a variable rate of interest. Series EE bonds are guaranteed to double their face value.

Advantages

  • Taxes deferred at a federal level and tax-free at a state level
  • Series EE and I bonds purchased after 1989 may be tax-free at the federal level for some higher education costs
  • Safe investment backed by the U.S. government

Disadvantages

  • Maximum investment of $10,000 is allowed
  • Taxes on interest apply if bond earnings are not spent on tuition and fees
  • Require a long wait until bonds reach maturity (20 years for EE bonds)

Roth IRA

A Roth IRA is a retirement account. Earnings and withdrawals after age 59 1/2 are tax-free. You can, however, open a Roth IRA in a child’s name if they have earned income. You can withdraw funds for qualifying education expenses at a qualifying institution for a qualifying family member.

Advantages

  • 10% early withdraw fee is waived when funds are spent under qualifying circumstances
  • Many investment options available
  • Retirement accounts are not counted as an asset for federal financial aid

Disadvantages

  • May be subject to income taxation
  • Maximum investment of $5,500 allowed in 2018; $6,500 for taxpayers 50 and over in 2018
  • Income restrictions for maximum investment
  • Roth IRA withdrawals count as income when applying for federal financial aid

Kids Can Help

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The burden of a student’s education does not have to be all on the parent. The best way to save for college has the student contributing, too. Some experts recommend paying a portion of your child’s education cost and expecting them to cover the remainder. The balance of the cost to the student can be covered through loans, grants, and scholarships.

Scholarships

If you worry about the burden of student loans, apply for scholarships. They do not have to be paid back. Scholarships are available to those involved in sports, clubs, and scholarly pursuits. Many employers and organizations also provide scholarships. A small investment of time to write an essay or fill out an application can lead to cash results.

Advanced Placement Classes

Many schools offer the option to take Advanced Placement (AP) classes. These courses allow students in high school to earn credits for college. If high school students can handle the classes academically, they will not have to pay for them in college.

Employment

An after-school or summer job is a great way to gain experience. For students, it could be the best way to save for college. Encourage students to save the money they earn. Teach them how to budget and manage their own earnings. Many banks offer student accounts with no fees or minimum balances.

Conclusion

There is not one best way to save for college. Both students and parents must plan for their child’s higher education, whether it is a two- or four-year degree, or beyond. The ideal time to start saving is when your child is young because you have time to grow your investments. However, even if your child is already a teen, it is never too late to start. Having a little saved is better than having nothing at all. Wherever you are in your journey of saving, finding the best way to save for college is important for your child’s future. 

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