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How to Save for College: A Crash Course

Personal Finance
kid brother hugs older sister at college graduation as family is successful in how to save for college

As a parent, you want to ensure you're setting your child up to succeed — and education plays a large role in that success. You've probably been thinking about how to get them from their first day of kindergarten to their first day of college since the day they were born. Whether that time is finally here or many years down the road, there are many ways you could prepare.

Whether your child decides to attend a public or private university, higher education can be costly — even if you've been saving for 18 years. The average cost of tuition and fees at a four-year college can range anywhere from around $10,500 to well over $37,000 a year, according to the College Board.

Luckily, from college savings 529 plans to savings bonds, scholarships and grants, there are many ways you could offset some of the costs of college and pay for your child's education.

College Savings 529 Plans

A college savings 529 plan is a savings account designed to help families set aside money for college. These plans include state-sponsored college savings plans and prepaid tuition plans. When you invest in a 529 plan, the earnings and withdrawals are not subject to federal tax and generally not subject to state tax, as long as you use the money to pay for qualified education expenses, such as books, computer equipment, room and board, tuition and other fees.

Prepaid tuition plans, which are sponsored by states, let you prepay future tuition expenses. Some states offer tax deductions and tax credits for contributing to a prepaid tuition plan, and in some cases, there's some flexibility with how you can use the money if your child decides to go to an out-of-state school. However, rules vary by state, so it might be helpful to do some research beforehand.

College savings plans let you save money for college in an individual investment account. States or state agencies sponsor these plans, which are usually managed by a financial institution. Consider visiting your state's website to get more details about available 529 plans and how to sign up.

Coverdell Education Savings Account

For families who don't have a lot of wiggle room in their budgets for saving each month, a Coverdell Education Savings Account (ESA) could be an option. A Coverdell ESA is a popular account that helps families save for future education costs, including qualified elementary school, high school, college and grad school expenses. You could set up a Coverdell ESA at banks, mutual fund companies and other financial institutions. With these accounts, you don't pay taxes on your earnings until later, and qualified withdrawals are tax-free if you make them before the beneficiary turns 30.

The Internal Revenue Service (IRS) allows families with an annual adjusted gross income of less than $220,000 to save up to $2,000 a year in an ESA for their child's education. This $2,000 cap applies no matter how many accounts you open — even if another family member opens an account for your child. ESA contributions also aren't tax-deductible, but earnings are tax-free. Withdrawals are also tax-free so long as the amount you withdraw isn't more than your child's qualified education expenses.

UGMA & UTMA Accounts

You could also set up custodial accounts to help safeguard assets like bonds, stocks, cash and even real estate in a trust for their child. The Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts serve this purpose.

These accounts allow parents to transfer assets to their children without the legal legwork involved in hiring an attorney or going through the courts. The thing to remember is that these accounts are not limited to college, so your adult child could choose to spend the money in any way they want.

The assets in the trust are overseen by a custodian until the child reaches the designated age at which they can take control of the account (each state sets its own age requirement). Please note that UGMA and UTMA accounts could have a significant impact on financial aid eligibility since everything in these accounts is considered the child's assets.

Scholarships, Loans & Grants

In addition to the money your family saves, you could also consider outside help in the form of scholarships, loans and grants. If your child has participated in a specific sport, extracurricular or volunteer activity, he or she may be eligible for scholarships and grants from different organizations.

Some of these grants or scholarships may be for a few hundred or several thousand dollars, so even if they don't cover the entire cost of your child's time in college, every little bit adds up.

Another possibility? Student loans. The federal government offers several loans with lower interest rates than what a private financial institution may offer, so you may want to review all the available options before you agree to a loan. College is often the foundation for your child to start their career, so it could help to think of student loans as an investment in your child's future. 

Savings Bonds

Series EE and Series I savings bonds are government-backed investment tools that could help build college savings. Though their rate of return is usually lower than other types of investments, you don't pay any taxes when you cash in bonds if you use them for education expenses. The IRS only counts tuition and fees as qualified expenses — not room and board — so bonds might be less flexible than other college savings methods.

Many parents worry about how to save for college, but these options could help ease the process — especially if you start early. Which investment vehicle you choose will largely depend on how much you can afford to save, the amount of flexibility your family needs and the tax advantages or financial aid implications of each plan. You may want to consider all of these factors and weigh the pros and cons before choosing a long-term college savings plan.

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