Saving for college can be a financial hurdle for parents and students. The average cost of tuition at a private university for the 2014-2015 school year topped $31,000, according to the 2014 Trends in College Pricing report by The College Board. In-state students at public colleges can expect to pay over $9,000 each year while out-of-state students will pay, on average, over $22,000.
A college savings plan allows you to prepare for the expense of a higher education. From 529 plans to Coverdell College Education Savings accounts, you can find ways to grow a college fund. Consider the following ways you can save.
Five College Savings Plans You Need to Know About
1. Savings Accounts and CDs
A savings account is a tried-and-true method for building a college fund. Unlike other savings plans, the money in your account can be easily accessed in an emergency. For some parents, having the ability to use college savings as a backup emergency fund can be important.
As you consider savings accounts, research interest rates offered by local financial institutions. Your rate will determine how quickly your money grows. Certain banks will offer higher rates for customers with large savings.
Certificates of deposit (CDs) offer above-average interest rates for customers willing to lock in investments for set periods of time. With flexible terms, you can use short- and long-term CDs to help grow your college fund. If you want to save with certificates but need some flexible access to your money, you can build a CD ladder.
With a CD ladder, you open a series of certificates with varying term lengths. You want to space out your CDs so that each one matures at a different time, allowing you to access part of your savings more often. Because banks offer higher rates the longer you invest your money, you can build a long-term CD ladder to potentially grow your money faster.
Opening Savings Accounts and CDs
Savings accounts and CDs are common banking products. You can comparison shop rates and features offered by local banks and credit unions. You might find some accounts have annual or monthly fees, service charges, and other hidden fees that can eat into your savings. Make sure you read the fine print and compare features to help you make the most of your money.
Read: 31 Worst Fees in America
2. 529 College Savings Plans
529 plans are qualified tuition savings accounts. Withdrawals on 529 plans are not subject to federal taxes, as long as you use your money on qualified college expenses, such as tuition costs. This type of college savings account helps you save with incremental payments and tax exemptions.
With the ability to make beneficiary changes, you can start savings early. “Saving can start before birth with a 529 account with a parent as the beneficiary, since the beneficiary can be changed later to the new child,” said Rick Mayes, CFP and principle advisor and owner of Mayes Financial Planning in Carlsbad, Calif.
There are two types of 529 plans: prepaid tuition plans and college savings plans. Each state sponsors at least one type of 529 plan.
Prepaid tuition plans allow savers to purchase units or credits at participating colleges to pay for tuition and other costs. A prepaid tuition plan has numerous benefits, such as:
- The ability to lock in tuition prices at certain public and private colleges
- Lump sum or installment payments based on the beneficiary’s age or number of years of tuition purchased
- Plan guarantee or backing by the state
College savings plans, however, are more common and flexible than prepaid tuition plans, according to Mayes. Prepaid tuition plans generally require funds to be used toward tuition and other mandatory fees, and you might face age and grade limits. A college savings plan, on the other hand, covers additional expenses, such as the cost of books, a computer and room and board.
Although this type of 529 plan does not allow you to lock in college costs, there are no age limits either. Other benefits of a college savings plan include:
- Open enrollment all year
- No residency requirements
- High contribution limitations
Overall, 529 plans offer great opportunities for saving. “529 plans are often the best savings vehicle for college savings, since earnings are not taxed if used for qualified educational expenses,” said Mayes. Unlike traditional savings accounts and CDs, however, your plans can only be used for college, meaning you can be taxed and penalized for withdrawing funds for non-qualifying expenses.
Opening 529 College Savings
You can start 529 plans with brokers and nonprofit organizations. You might be subject to certain fees if you work through a broker, as opposed to the plan’s sponsor or program manager.
In general, your plan will allow you to distribute earnings among a number of investment options. Your investment mix can include equity, fixed-income and stable value funds, among other options. On starting a 529 plan, Mayes said: “Key factors [to consider] are low expenses, a good set of investment options and a sound, age-based allocation that becomes more conservative as the child gets closer to college.”
3. UGMAs and UTMAs
Under the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act, UGMAs and UTMAs allow you to transfer assets to minors. While these accounts are not specifically designed to finance a college education, they are often used by parents because they allow you to bypass certain attorney fees.
UGMAs and UTMAs have similarities. Each type of account is managed by a custodian. The money your child receives can also be subject to taxation and affect their financial aid eligibility.
Depending on the state you live in, your UGMA and UTMA can automatically become your child’s property when they become 18 or 21. Your child can also choose not to use funds on a college education. Because UGMA and UTMA transfers are irrevocable, and you cannot change beneficiaries, once you have deposited money, your funds are committed.
Contributions to your UGMA is limited to bank deposits, securities and insurance policies. With a UTMA, however, you can transfer virtually any kind of asset to your child.
How to Open UGMA and UTMA Accounts
UGMA and UTMA accounts can be opened at many financial institutions. Be certain to understand your individual plan’s terms. Because the assets your child receives can impact financial aid eligibility, you will want to plan ahead for how much you should save.
4. Coverdell Education Savings Accounts
A Coverdell Education Savings Account (ESA) is another tax-advantaged savings plan. An ESA can only be opened for a beneficiary under the age of 18. Parents who meet income requirements can contribute up to $2,000 each year per child. With an ESA, you can invest in stocks, mutual funds, bonds, CDs, money market funds and simple cash.
Contributions can only be made as cash deposits and transfers. Once the beneficiary turns 18, you cannot make further contributions. ESA funds may be used for higher education expenses, as well as elementary and secondary education expenses.
How to Open ESA Accounts
Coverdell ESAs can be opened at banks and IRS-approved entities. To open an account, you must have an adjusted gross annual income of less than $110,000, or $220,000 for a joint return. Note that if you contribute more than $2,000 in one year to your child’s ESA, you will need to pay a 6 percent excise tax on excess contributions.
5. Stocks, Bonds and IRAs
Purchasing stocks, bonds and other investments can help you grow college savings. Each method has varying risks and rewards, so it’s important to research and compare options.
Stocks can be high- or low-risk investments, depending on how you invest your money. Middle-range mutual funds are a safe, moderate option for conservative investors.
Bonds are another moderate investment option. When choosing a bond, you can choose your term length, opening cost and yield amount. Your bond gains interest over time. The longer your bond’s term, the greater its earning potential.
Roth IRAs can do more than help you save for retirement. If you meet certain conditions, you can withdraw from your IRA without being taxed. If you have the funds, you can pay for your child’s education. Be certain you have enough leftover to retire, however.
How to Obtain Stocks, Bonds and IRAs
You can obtain stocks and bonds at most banks and credit unions. You can also purchase these investments through a broker, such as Edward Jones or Charles Schwab. Roth IRAs are available through banks, brokerage firms and mutual fund and insurance companies.
Whether you invest in a Coverdell ESA or use a CD ladder to snowball savings, you can find ways to help you or your child afford university costs. Weigh options available to you and consider how they fit into your college savings plan. Consider your financial situation as you review options and see how different financial products help you save. Even if you a small starting investment, your savings can quickly grow over the years.