How to Save for College: 529 Plans, Coverdell Education Savings Accounts, and More

It’s never too early or too late to start saving for your child’s college. Some people start saving for college as soon as their child is born. There are some great options tax-advantaged ways available to help you save for college costs like tuition, room and board, books, and more. The sooner you get started on saving, the longer the money has to grow and the easier you’ll cover the cost of college.

What Is A 529 Plan?

A 529 plan is a tax-advantaged account that can be used as a college savings plan. The account earns interest, so any money you put into it will grow and help you pay for college. There are many 529 plans available and most states have at least one 529 plan.

The rules vary between plans and states, but all of them have tax benefits. You won’t pay any federal tax on money that is used for education expenses. The rules on what they will and won’t pay for a pretty specific, so it’s worth looking closely at rules of your specific 529 college savings plan.

529 Savings Or 529 Prepaid Tuition

There are two types of 529 plans: savings plans and prepaid tuition plans. Savings plans are far more flexible and a more popular choice, but both have benefits.

529 Savings

Money from 529 savings funds can be used to cover a variety of education-related expenses, such as college tuition and fees, room and board, books and certain additional expenses. 529 savings accounts previously only covered higher education expenses, but the rules have recently been changed to include k-12 tuition as well as certain apprenticeship programs.

529 Prepaid Tuition

A 529 prepaid tuition plan is far more specific. It allows you to lock in fees at a particular college. These fees are locked in at their current rate and then paid off by contributing money to the fund. This money is only for tuition and doesn’t cover other expenses. It’s obviously far less flexible, but there are some circumstances where it might be appropriate.

What Happens If There’s Money Left Over In My 529?

Money left in a 529 plan can be used to pay for the education-related expenses of another relative. This money will not be subject to penalties or taxation. All the money in the account may be withdrawn, but money not used to pay for education will be taxed and will receive a 10% penalty.

Roth IRA vs 529

A 529 fund and Roth IRA work on very similar principles. The 529 is designed to save for education expenses, while the Roth IRA is designed to save for retirement. Both grow without being taxed and both can be withdrawn from tax-free, provided certain criteria are met.

Money from 529 college savings plans which is is not used to pay for qualified education expenses is subject to tax and a 10 % penalty. Similarly, money withdrawn from a Roth Ira before the age of 59 and a half is also subject to tax and a 10% penalty. However, there are 2 exceptions:

  1. Money used for qualified college education costs will be taxed, but will not be subject to the 10% penalty
  2. You may withdraw money which you contributed tax-free. This amount does not include any interest earned on the money (which will probably be a substantial proportion of your balance). Only the amount which you contributed may be withdrawn tax-free before the age of 59 and a half.

Which Should I Choose?

The Roth IRA is a much more flexible way to start saving for college, because it doesn’t dictate the way that money should be spent and only when you can withdraw the money. If you’re sure you will have college or education related expenses, then 529 plans are the way to go, because they allow you to pay for those expenses without the worry of incurring penalties of paying tax.

It’s important not to save too much money in 529 plans, knowing how much to save for college can be tricky and the tax incentives make 529 plans an attractive way to save, but remember that money in 529 plans cannot be used for education-related expenses will be taxed.

Coverdell Education Savings Account

A Coverdell Education Savings Account provides many of the same benefits as a 529 fund and functions in much the same way. They are however, only available to qualifying income groups and can be used more broadly to cover k-12 expenses such as books, equipment, academic tutoring and special needs services. Coverdell accounts also have more stringent contribution limits than other options.

Upromise

Upromise is a great tool to use if you’re wanting to balance paying off your own college debt, saving for retirement, and making contributions towards your children’s college fund.

How Does It Work?

Upromise is a rewards program. You receive rewards for swiping your credit card, shopping online, and even dining out. These rewards are deposited into a 529 fund of your choice and can grow and accumulate while you go on with life.

The great thing about Upromise is that those small rewards add up quickly without you affecting your other savings plans. Upromise makes saving for college easy because you can be adding to a 529 account without feeling the effect on your budget.

Those small amounts add up quickly and because you don’t have to pay taxes on the growth, they compound over time to add up to a decent amount. You’re not limited to rewards and can make additional contributions to the 529 fund at any stage. Many grandparents also sign up to Upromise as a fun and easy way to make painless contributions to their grandchildren’s college savings.

How Much To Save For College

It’s difficult to say just how much you will need to save to cover the costs of college. The amount varies depending on which school and course you choose and how much money can be made available through financial aid and scholarships.

According to the National Center For Education Statistics, the average cost in 2018 was around $34000 for an undergraduate degree. That number is substantially higher for private institutions and slightly lower for in-state, public schools.

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