5 Ways To Save Money For Your Child’s College Education

Choosing the wrong savings plan for your child’s future college could cost thousands in avoidable taxes and missed financial aid opportunities.  Do your research and check into all of the ways you can save for your child’s college education.  Select the saving plan that works best for you and start your savings immediately.  Even if you only save $50 per month per child, it will help avoid you racking up student loan debt.

#1  Opening A Savings Account
Many families open a savings account in a child’s name to help save for their college education, but is that really the best option?  It may seem like a really smart move to tuck money away for their education when your child is young, but most of the time it is not enough because the interest rates on savings accounts are too low.  Although the risk is low, it is not the most effective way to save for college.  In addition you need to be aware that your students’ income and savings have a bigger, more negative, impact on the availability of financial aid than parental assets and income.  Your student’s financial aid is based on income and assets from the year prior to applying for financial aid so students with sizable savings accounts often lose a portion of free college money.

#2  529 College Plans
One of the most popular ways to save for college is through a college specific savings plan.
Think of 529 college savings plans as a way to allow parents to save for a child’s education tax-free through a variety of investment options similar to an IRA or 401(k) plan.  Some of the age-based investment packages put funds in aggressive investments when your child is young, and then automatically switches the funds to more stable options when your child nears college age.  Some state-sponsored college savings plans, in states such as California and Kentucky, offer big tax advantages.  In fact, the gains on these accounts are tax-deferred and as long as the parents use the funds to pay for qualified tuition expenses, they will never pay taxes on those funds.  The money in the 529 college savings plan can be used to pay for either for undergraduate or graduate studies at any accredited two- or four-year campus in the United States.  

Keep in mind that a 529 plan belongs to the parent, not the child, which means the
parent is the account owner and can change the beneficiary, if needed.  Therefore, if a parent invests in a 529 plan and their child chooses not to go to college, the parents the account can change the beneficiary so the money will still be used for education.  This prevents the child that is not going to college from taking out the money out for non educational expenses.

Although 529 savings plans offer significant advantages, there are some restrictions you need to be aware of before investing.   The 529 college savings funds can be withdrawn tax-free only for qualified education expenses, including tuition, books, fees, supplies, and room and board. Any money that is withdrawn for unqualified tuition expenses is subject to income tax and a 10 percent penalty on earnings.  Another disadvantage is that account owners can only switch how money in these plans can be invested twice a year.

#3  Roth IRA
Another option for parents is opening a Roth IRA in the child’s name once he or she begins earning income.  This can give their child a solid financial start.

The downfall is that when your child turns 18, they control the account.  Another downfall is that there are restrictions on Roth IRA withdrawals in order to keep investors from taking earnings out penalty-free until the age of 59 1/2.  However, one of the exceptions to this rule allows early withdrawals due to specific circumstances such as hardships, purchasing a first home or qualified education expenses.

#4  Prepaid Tuition Plans
Prepaid tuition plans are designed for parents who are sure that their child will attend an in-state public university   The plan is appealing to parents because it allows them to pay for tuition credits in advance at a predetermined price.  Although the prepaid 529 plans retain the same tax, financial aid and parental protections as 529 college savings plans, they are protected from  swings in the stock market.

The disadvantage of prepaid tuition plan is that if the child decides to go to school out of state.  Although you will still receive a return on your money, it will not be the full value of the plan.  For instance, if you prepay for one year of tuition at a Virginia state school at a locked in price of $14,000 and the tuition increases to $22,000, you would still receive a year of tuition at the prepaid price.  However, if your student chooses to attend a college in Pennsylvania, they will only receive about $15,000 or $16,000 towards their tuition.

Similar to the 529 college plans, the prepaid tuition plan holders can change beneficiaries at any time.  However, the prepaid college plan can only be used for college tuition to avoid penalties.  Anything other than college tuition will be charged a 10 percent penalty plus income tax on funds used for other college expenses

#5  Trusts
Establishing a trust in your child’s name is another option for parents.  However, these plans often have legal, administrative and tax fees that can be costly for the beneficiary.   Another downfall is that the money usually belongs to the child and the parent will have no control over how the money is to be spent.  The biggest downfall of a trust is that it can have an enormous impact on financial aid than parent-owned assets.  Colleges expect a family to use 20% of a dependent child’s funds each year to pay for college, while parents are only expected to use 5.6% of their own assets to pay for college expenses.  Therefore, if your child is the sole beneficiary of a $25,000 trust, your child’s financial aid eligibility will be reduced by $5,000.
If that is not bad enough, your child will also need to report trust monies received as annual income on the FASFA form which can further reduce aid eligibility by as much as 50% of the amount of income.
 
The biggest mistake parents make is not saving at all for their child’s future.  Many parents believe that student loans will cover their child’s education not realizing that they will be responsible for an expected contribution once they fill out the FAFSA (Free Application for Federal Student Aid) form.  If you don’t have a means to contribute, you will be asked to finance your portion of your child’s college education via personal loans or Parent PLUS loans.