Saving for college is a huge task. Not only does the cost rise faster than inflation you have a very short time frame in which to save. There are some vehicles to help you get the biggest bank for your college buck. None are perfect but all are better than nothing.
529s are the most common way to save for college. Each state offers a different plan and you are not required to use the plan from the state in which you live. So definitely take the time to look around and find a plan that meets your needs. The older the child the more conservative the plan you will need.
They are basically taxed like a Roth IRA. Which means contributions are after tax but growth is free from federal taxes. Most states also offer tax free status on growth for 529s but double check the laws in your state just to be sure.
The money in the plan can be used for qualified tuition expenses and anything not used for that purpose has a 10% penalty and the growth is taxed as income.
The only contribution limit is that they can’t exceed the “amount necessary to provide for the qualified education expenses”. If you withdraw more than $13,000 per year per kid then there starts to be gift tax issues. You can learn more about 529s here and here.
A Coverdell ESAs is very similar to a 529. The only real benefits of the Coverdell is that they offer a little bit more flexibility investing wise. In the past they could be used to pay for education expenses in grades K-12 not just college but that changed last year.
They have a contribution limit of $2,000 per year per kid and the entire balance must be used by the time child turns 30 or the money is automatically transferred to the kid, along with taxes and penalties.
You can learn more about Coverdell ESAs here.
The big drawback of using educational savings plans for college savings is that if your child decides not to go to college you have to pay a penalty to withdraw the money out of the account. Yes, you can transfer the money to a family member but, honestly, how realistic is that option? I love my nieces and nephews but I don’t see myself paying for their college. And I don’t see my in-laws paying for my kid’s college either. So the reality is that you will end up paying 10% on the money if your child doesn’t end up going to school.
If that is a big concern for you then you can always just save the money in mutual funds.
Mutual funds offer tons of flexibility. You can obviously invest in anything you want not just what is available in a 529. Plus if it’s not used for college then you just move on with your life, no penalties or transfers or anything. The drawback here is that you lose the favorable tax treatment of a 529 and will have to pay capital gains taxes each year.
Feeling guilty for not saving for college?
Go ahead and call me the worst parent in the world, but I don’t plan on paying for my children’s education. I know I’m in the minority on this but I honestly don’t see that as part of my responsibility to them. They are welcome to live at home while they go to school full time. They can work for their tuition money while I provide all the essentials of life. I might even chip in for books or other needs if I can. I’m not saying they are totally on their own at age 18 but I don’t plan on putting aside several hundred dollars a month in anticipation for their college costs. If things change for us financially my thoughts on this might change too. But until my retirement needs are 100% covered I won’t be saving for college.
Plus, help for college doesn’t have to come before or during college. Help can also come later by paying off student loans or putting a down payment on a house. Help can come after you are no longer under the constraints of mortgage payments and raising kids. So it’s not lost cause just because you can’t save for college right now. Your help will always be appreciated, I’m sure.