Since the price of college has been steadily increasing over the past few decades, saving enough money to send your child to college can feel daunting. However, if you start a college fund while your child is young, you could have a solid reserve by the time they graduate high school.
Each savings account is different, and what’s right for one family may not be a good fit for yours. Explore the different types of savings accounts before deciding where to put your money.
Starting a College Fund with a Bank Savings Account
When you decide to put money aside for a college fund, the first place that comes to mind is probably your local bank. Most banks will let you open a savings account with only a small deposit, and you can keep the account growing with automatic transfers from your checking account. One of the biggest pros of a bank savings account is that there’s very little risk of losing your money if your bank is federally insured. However, the money is easy to access, which could tempt your family to spend it on vacation instead, and most savings account interest rates are low compared to other options.
Starting a College Fund with a Mutual Fund
If you’re comfortable with taking on risks, you could put your college savings into a mutual fund. A mutual fund diversifies your investments by spreading them across multiple different assets. There are a few upsides to having a mutual fund: They give your money the ability to grow, and they’re easy to buy and sell with a broker or online account.
There are some caveats that come with a mutual fund that are worth keeping in mind. Even if you don’t sell your shares, you might have to pay yearly capital gain taxes on your investments. You will also have to pay taxes when you sell the fund to pay for college. The biggest downside of a mutual fund is the potential for financial loss should the market take a downturn when you need to sell. Lastly, if the fund is in your child’s name, their eligibility for financial aid could decrease by 20%.
Starting a College Fund with an Education Savings Account (ESA)
An ESA is a trust or custodial account that helps you save towards your child’s education expenses. Benefits include tax-free earnings growth and tax-free withdrawals when spent on qualifying expenses. Originally, ESAs could be used to pay for K-12 education and college, whereas 529 plans could only be put towards college. However, both plans can now be used for K-12 expenses. ESAs need to be dedicated to one beneficiary under the age of 18, and the funds need to be used before they turn 30. Exceptions can be made for beneficiaries with special needs. The same beneficiary can be named on multiple ESAs, but the total yearly contribution to one ESA cannot exceed $2,000. ESAs are available to parents with a yearly gross income of less than $220,000 per year. Both ESAs and 529 plans can be spent on more than school tuition. Qualifying expenses also include books, computers, room and board, school supplies, and more.
Starting a College Fund with a 529 Plan
Like an ESA, a 529 plan is an investment account that offers tax benefits when put towards your beneficiary’s education expenses. They can be used to pay for K-12 and college tuition, apprenticeship programs, school supplies, room and board, and student loan payments. Features of the 529 plan vary depending on your state. Each state offers its own 529 plan and investing in another state’s plan is an option. Unlike the ESA, each 529 plan sets its own contribution limits. The contribution limit for a 529 plan can be as high as $300,000 per student. Overall, the 529 plan has fewer restrictions than the ESA. For example, you don’t need to empty the account by age 30, and any income qualifies for a 529.
Now that you know your options, you can start thinking about which fund is right for your family. The sooner you start saving for college, the longer your funds have to grow. Interested in learning more? Get more finance and lifestyle tips on our blog.