Starting a College Fund for Your Child
Starting a college fund for a baby is a great way to invest in your child's future. During the 2019-2020 school year, CollegeBoard estimated that the average in-state tuition costs nearly $11,000 per year, and average costs for private schools approached $40,000.
These stats can feel overwhelming. Unless the country majorly overhauls its education system in the years ahead, you can expect your baby's future tuition and lodging to be well above those numbers. However, beginning to financially plan now will allow your child more options and reduce or eliminate the need for student loan debt later.
Remember, the earlier you start saving, the more time you'll have to grow that college fund for your baby.
When to start a college fund for kids
When you prepare to have a baby, the to-do list is already long, from buying all the necessities to updating your health insurance plan to understanding life insurance basics. But learning how to start a college fund as soon as possible doesn't have to be stressful. Think of it as empowering; you're getting way ahead on your financial planning for your child.
Plus, you have more time to earn potential returns on your portfolio by investing early. You can also invest less each month, compared to starting later in life and having to catch up with higher contributions.
If you're eager to begin aggressively growing an education fund even before the baby is born, you have options. The first is to invest some money in a taxable account and later transfer the money to your chosen education account for the child. The other option is to open a 529 account with one of the parents as the beneficiary. You can change the beneficiary to your child once they're born.
4 types of college savings accounts
Let's cover four types of college education funds to consider for your baby.
A 529 plan is one of the most popular options for starting a savings account for a baby. A 529 plan is an investment account that's sponsored by individual states. You don't necessarily have to choose the 529 plan associated with your state; you can evaluate all the state plans' performances and fees.
Why open a 529 fund? There are two sets of potential tax benefits. The first benefit comes when you make your contribution. You won't get to deduct contributions from your federal taxes, but you may be able to deduct a certain amount from your state taxes. Check your specific state's regulations for details.
The major draw of a 529 is that the investments and earnings in the account are tax-deductible when used for qualified education expenses, such as tuition, room and board, textbooks, and computers.
Universal Gifts to Minors Act (UGMA) accounts
A UGMA account is a custodial account that allows parents to save on behalf of their children until they reach a certain age. Then, account ownership is transferred to the child (depending on your state, this could happen between ages 18 and 25).
There are some drawbacks to using a UGMA account as your college savings plan for a baby. The primary issue occurs when it comes time to apply for federal student financial aid. Since a UGMA account is considered a student asset rather than a parent asset, it can lower the amount of aid your child qualifies for (at least under today's rules). However, a 529 held in a student's or parent's name is also considered when calculating financial need.
The benefit of a UGMA is that the funds can be used for any purpose, so if your child decides not to attend college, they can use the funds without incurring a penalty.
IRAs are typically reserved for retirement savings, but you can use these accounts to pay for higher education without incurring the standard 10% early withdrawal penalty. IRA funds can be used for yourself or your child's qualified education expenses, including tuition, books, and room and board (with a minimum of part-time enrollment).
There are different tax implications based on whether you're using funds from a traditional or Roth IRA. With a traditional IRA, your contributions are tax-free, which means withdrawals are taxed. So, while you'll avoid the 10% penalty, you do have to pay income tax on college-related withdrawals.
A Roth IRA, on the other hand, comes with taxed contributions. That means eligible withdrawals aren't taxed — and that includes your investment earnings. If you're eligible for one when you have a baby, a Roth IRA could be a wise investment tool.
Coverdell Education Savings Account (ESA)
A Coverdell ESA is like a 529 plan. However, it's designed to help parents under certain income limits save for college. Single tax filers must earn less than $95,000, while those married filing jointly can qualify with income as high as $190,000. You may contribute up to $2,000 a year for each child. Distributions are tax-free if they're used for eligible education expenses by the account beneficiary (your child).
It's never too soon to begin a new financial plan for your baby, including starting a college savings fund. Also, remember to update your life insurance policy so that if you pass away before you've finished saving for college, your policy benefits will step in to help fill in the gaps.
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The information and content provided herein is for informational purposes only, and it is not to be considered legal, tax, investment, or financial advice, recommendation, or endorsement. You should consult with an attorney or other professional to determine what may be best for your individual needs.