Fast forward a bit and your little newborn will be heading off to #college. You’ll be yelling “eat your vegetables!” as they pull out of the driveway. You probably won’t be yelling that actually. Because, let’s be real, who actually yells that? But you’ll yell something, maybe, and even shed a few tears. At least I know my mom cried. Probably from happiness that they were one step closer to having both kids off the bankroll. That’s worthy of celebration in my book.
But you know what isn’t worthy of celebration? Student loans. So, here are the 4 ways, along with some advantages and disadvantages, of saving for your child’s college education:
- The 529 Plan
If you are committed to saving for college this, in my opinion, is your best choice. Here are some of the benefits of this type of account:
- Tax Benefits: Earnings inside a 529 account grow tax-free, which allows it to grow faster than it would inside a regular brokerage account. If you use the money on qualified higher education expenses, the withdrawals are tax-free as well. Additionally, some states allow for you to deduct your contributions for state income tax purposes.
- High Contribution Limits: A married couple can, most of the time, contribute up to $28,000 per year into the account. Additionally, there are no income limit phase-outs with this type of account.
- Beneficiary Change: Say your first child got a full ride to a school, but they have a fully funded 529 account. You can change the beneficiary of the 529 to your second child with no problem.
- Great for gifts: This type of account allows gifts to be made into it. I really hope my mom or mother-in-law is reading this (hi Mrs. Becker!). It is also common for grandparents to open up an account for their grandchildren.
There are definitely some cons to this type of account as well. The biggest one being, if you pull the money out and it is not used for qualified educational expenses, you are hit with taxes and an additional 10% penalty. Additionally, you have limited investments inside of this account. This is a major drawback compared to the Roth IRA or the Brokerage account.
Overall, this is my favorite type of account if you are set on saving for college. I recommend this only if your other savings goals are being met first or you know the grandparents want to help contribute.
2. A Roth IRA
You might be thinking to yourself, “isn’t a Roth IRA a retirement account?”. Yes, yes it is. However, a Roth IRA can be a good way to save for college as well.
- Tax-free growth: One of the major benefits of a Roth IRA is that your assets grow tax-free within the account. You don’t get a deduction for your contributions like you would with a 401(k) or Traditional IRA income, as these are after-tax dollars.
- Multi-Use Purpose: If your child doesn’t need to use the funds for college, you can keep them in the account and allow them to grow until you need to use the money for retirement.
- No Penalty for Withdrawal: The reason you can use a Roth IRA for college savings is that higher education expenses are a qualified withdrawal reason. As such, you won’t be assessed the 10% penalty if you pull out funds early for this type of expense. You will have to pay taxes on the earnings, but that is it. Additionally, you can withdraw your contributions at any time without penalty.
- Avoids Financial Aid Calculation: Assets held in retirement accounts are protected against the FAFSA application.
However, it isn’t all fun and games with the Roth IRA. While assets held within a retirement account don’t count towards financial aid, if you withdraw money (even for college expenses), this is counted as income and will be calculated in the next years financial aid calculation. Additionally, there is a contribution limit of $5,500 per year. While not a deal breaker, it is considerably lower than the 529 plan.
Overall, this is a good option for saving for college if you aren’t sure you are going to use the funds for retirement or college. However, if you are committed to saving for college, I would still recommend the 529 account.
3. A Classic Brokerage Account
Regular brokerage accounts don’t offer any tax benefits, but do offer a great deal of flexibility. There are unlimited investment options within a brokerage account and you can use the money at any time for any purpose.
However, the biggest downfall is that you don’t receive any tax benefits. You don’t get tax-deferral or tax-free growth within the account. As well, some mutual funds require a minimum investment, which could create a barrier to entry and derail you from even starting to save.
There is a fine line between sacrificing retirement and saving for your child’s education. However, if you have decided you want to fund their college, then I would choose a 529 account. If you are still unsure if you are on track for retirement and want to give yourself the flexibility in the future to use these funds for retirement instead of college, I would choose the Roth IRA or the Brokerage Account.
Lastly, there are a couple more options out there like the Coverdell ESA, a UTMA/UGMA account, and a regular, plain-old savings account. However, I believe the three options detailed above are going to be your best options. Hopefully this helps you on your way to funding college for your kids!