If your kid’s still trying to master tying shoelaces, it can be hard to focus on saving up for college. But no matter how young your child is, it’s never, ever too soon to start saving up for college tuition. Though tuition costs recently leveled off, they’ve still risen faster than the rate of inflation or average wage growth. That’s why it’s important to look for the best college savings plans available to you now and start comparing them.
It might sound like a good idea, but starting a savings account for your child could actually be a mistake. That’s because colleges use students’ income and assets from the previous year to determine whether they qualify for financial aid. As a result, high school juniors with sizable savings accounts in their names could lose lots of free college money. Still, you shouldn’t lose sleep over this issue.
Best College Savings Plans: Which One’s Right For You?
When it comes to the best college savings plans, you have three major options to choose from. Each one offers its own compelling benefits, which can make putting aside college tuition money now a little bit easier. Below, we’ll list the pros and cons of the three best college savings plan available today.
Option 1: 529 Plans
A 529 plan is the paying-for-college equivalent of opening an IRA for your retirement. That means accrued interest in these exchange-traded funds don’t count as taxable income if you use them for college expenses. You can use these funds to pay for undergraduate or graduate tuition, books, fees, supplies, and room and board expenses. Check to see if your state offers tax breaks or credits for setting up your own child’s 529 plan. If your child doesn’t eventually enroll in college, you can always change the fund’s beneficiary and use that money elsewhere.
One 529 plan con is the 10% penalty and income tax you’ll owe for spending that money on non-qualified expenses. Here’s another thing to watch out for: Plan owners can only re-allocate the fund’s investments twice each year. In other words, these plans offer less freedom than a traditional mutual fund. Among the best college savings plans available, 529s may ultimately cost you if your child doesn’t pursue a higher education.
Option 2: Prepaid Tuition Programs
These plans let you lock in tuition costs now at current rates, which can be very appealing for some parents. On average, college tuition costs about 5% more every year, and that’s not likely to change anytime soon. However, you can only use prepaid tuition plans for in-state public universities, which will limit your child’s college application choices. Like 529s, these plans include built-in tax advantages — but you must spend that money on college tuition.
College admission officers suggest parents supplement prepaid tuition plans with 529s to cover additional university expenses, like books and housing. Combining two of the best college savings plans can reduce potential losses if your child chooses a different educational path.
Option 3: Coverdell Education Savings Accounts (ESAs)
Similar to 529s, ESA owners earn tax-free interest on their investments, but with one small difference: annual contribution limits. You can only put $2,000 into your ESA each year, but it covers any qualified educational expense — not just college. In fact, you can use ESA funds to pay for elementary and secondary school costs as well as higher education.
Recent research shows it takes just over five years to earn a bachelor’s degree in the United States, on average. While your child’s grandparents may help cover costs—along with scholarships and part-time jobs — it’s best to start saving now. The best college savings plans all offer the most important benefit of all: Peace of mind for years to come.
