This article was last updated on December 15
A set of three couples sit around an oval table, discussing the future of their newborns. A father asks, “Has anyone actually started saving for college yet?” One parent cries, “Ugh not me.” Another parent tries to explain, “No, no you got time.” But then the “smart” couple confesses and says, “On no. We’ve actually started.”
If this scenario sounds familiar, that’s because you’ve probably seen it on TV. It’s the Gerber Life College Plan commercial, which happens to air quite frequently. Without trying to sound too “Ra-Ra Gerber” (to whom I have no affiliation with), the commercial does make a valid point: The earlier you are willing to start saving for your child’s future, the easier it will be to help compensate for the continuous tuition increases. While looking into the Gerber Life College Plan is a good start, there are some other ways you can start actively investing in your child’s future the moment he or she is born. To learn how, continue reading below.
In a nutshell, a 529 plan is a state or educational institution-run savings plan that is designed to specifically help parents fund for their child’s higher education. The money cannot be retrieved by the beneficiary (your child) until he or she reaches a certain age. There are two different kinds of 529 Plans. The first is a simple savings plan. This option functions just like a 401K or IRA, meaning you have the opportunity to contribute funds tax-deferred as well as invest in stocks or bonds from a list of options. Thus, the value of your account will increase or decrease depending on your investments. The second option is acquiring a prepaid plan. This option allows you to pre-pay all (or partial) costs of an in-state public college institution. But since the cost of education changes, a pre-paid plan can be a risky choice. Either option offers tax benefits. [See more details on how 529 plans work]
Coverdell Education Savings Account
A Coverdell Education Savings Account is also another IRS endorsed tax-advantaged investment account designed to help parents cover future education costs. It works very similar to a 529 plan since it grows tax free until awarded to the beneficiary; except unlike a 529 plan, contributions to the account cannot exceed more than $2,000 annually. The funds must also be used before the beneficiary turns 30 (there is no age limit on a 529 plan).
The beauty of investing in a 529 plan or a Coverdell Education Savings Account is that it will be in your name, the parent’s, so technically it doesn’t belong to the beneficiary (your child’s). This means he or she may still be eligible to receive a plethora of financial aid such as scholarships, grants, work-study, and low-interest loans. Even if you diligently save, encourage your child to find a way to pay for his or her own education.
While the options mentioned above are typically the most popular choices, remember that you can simply store funds in a regular savings account as well. Just make sure that you keep it separate and don’t tap into the account for your own personal needs. Every time you get a holiday bonus or refund check for example, put it in the savings account for your child. You should also try to cutting back on unnecessary expenses. For example, do you really need to get another car now that you paid off the old one? Instead, put the money you would to pay your car note into the savings account instead. You can end up saving a substantial amount of money by the time your child turns 18.