If you’re a parent, or are going to be a parent soon, there’s a good chance you’ve thought about the high cost of college. After all, the average cost of in-state tuition and fees is currently about $10,000 per year, and that’s in addition to room, board, books, and other expenses. So you can only imagine how expensive it will be when your kids reach college age. With that in mind, here’s a rundown of when you can start a college fund for your child, the best ways to start saving, and why it’s important to get started early.
One email a day could help you save thousands
Tips and tricks from the experts delivered straight to your inbox that could help you save thousands of dollars. Sign up now for free access to our Personal Finance Boot Camp.
By submitting your email address, you consent to us sending you money tips along with products and services that we think might interest you. You can unsubscribe at any time.
Please read our Privacy Statement and Terms & Conditions.
When can you start a college fund?
You can start saving for college expenses at any time, but in order to do it in a 529 plan or Coverdell ESA (more on those in a bit), there are a couple of things to know.
First, these accounts need to have a beneficiary for whom the account will be used. In order for your child to be named as the account’s beneficiary, you’ll need their Social Security number. Based on personal experience — I’ve been through the college account set-up process twice for my own children — you can expect to have it about two weeks after your child is born. Once you have it, you are able to set up a college savings account in your child’s name.
Having said that, there’s a way to get started even sooner — before your child is born. With 529 plans and Coverdell ESAs, you can change the beneficiary quite easily. So it’s possible to set up an account with yourself listed as the beneficiary, and then change it after your child is born.
I don’t see any reason to do it that early, but it’s possible. I started 529 plans for both of my children when they were just a few months old. And if you receive cash as a baby gift from anyone, it can make an excellent opening deposit.
The different ways you can save for college
There are several different ways you can save for college. For example, many parents simply choose to set aside money in a regular bank savings account, or even a checking account. Others use their own brokerage account to invest for college, and plan to sell investments and withdraw funds when the time comes.
Having said that, there are some advantages to using college-specific and other tax-advantaged savings vehicles. Here’s a quick rundown of the three main options in this category:
- 529 savings plans are administered by state by state and are structured similar to 401(k) accounts in terms of investment selection. Generally speaking, you’ll have one or two dozen investment funds to choose, and there are also age-based portfolio options that you can often choose. Tax-wise, contributions to a 529 savings plan aren’t deductible on your federal tax return, although they may be deductible on your state taxes. However, all qualified withdrawals for educational expenses are 100% tax-free, no matter how well your investments have done.
- Coverdell Education Savings Accounts, or ESAs, are brokerage accounts that allow the investor to invest their college savings in virtually any stocks, bonds, or funds they want. And they have a similar tax structure to a 529 savings plan, where qualified withdrawals are tax-free. The potential downside to using a Coverdell ESA is that you can only contribute $2,000 per year per beneficiary. On the other hand, 529 savings plans are only limited by a maximum account balance restriction, which is often in the $400,000 ballpark.
- Finally, Roth IRAs are also quite popular for college savings. Roth IRAs have the same basic tax structure as both 529 savings plans and Coverdell ESAs, plus college expenses are an allowed exemption to the IRS’s early withdrawal penalty. However, Roth IRAs don’t have to be used for college expenses. If you end up not needing all of the funds for your kids’ college education, you can simply save it towards your own retirement.
When should you get started?
The short answer is that you should get started as soon as possible. I’m not saying that you need to start a 529 plan for your yet-to-be-born children, but the longer you allow for your money to compound (and to ride out the market’s ups and downs), the better.
As a final thought, consider this simplified example. Let’s say that you want to have $25,000 available to help put your child through college once they turn 18, and that you can expect an average annualized return of 7% on your investments.
If you wait until your child is 10 years old to start saving, you’ll need to set aside about $2,100 per year, or about $175 per month in order to meet your goal. If you start saving when your child is five years old, the annual funding requirement drops to just $1,109, or about $92 per month. And finally, if you start when your child is born, you’ll only need to set aside $669 each year, or $56 per month in order to meet your $25,000 goal.
The bottom line is that the sooner you start saving for college, the easier it will be to reach your goal. So, if you’re able to start saving now, it may be a smart idea to not put it off any longer.
View more information: https://www.fool.com/the-ascent/banks/articles/when-to-start-a-college-fund-for-your-child/