6 Tax-Smart Ways to Start a College Fund for Your Child
While there are many paths to financial success and fulfillment in our modern society, college is still a necessary and wise choice for many young people. Unfortunately, tuition costs can be a roadblock for many families. In fact, the average cost of tuition in the U.S. at public colleges for the 2021-2022 school year was over $10,000, while private colleges cost $38,000. That’s why saving ahead of time is so important.
Planning ahead for your child’s college years while they’re young gives them an excellent starting point to reach their goals for higher education. A college trust fund not only pays for tuition, but also generally comes with tax deduction benefits as well.
Keep reading to learn how to start a college-fund for your child and discover the best saving and investment strategies available to you.
1. Start Saving Early
The safest and most financially productive time to start saving for your child’s college fund is as soon as they’re born, or as soon as you can after. With smart investments and compound interest, your fund can grow steadily over time, allowing you to contribute smaller amounts each month/year and get the same returns.
Starting early also gives you the opportunity to keep up with rising tuition and living costs. Keep in mind that tuition costs increase an average of 5-8% per year. When you start saving, take time to consider how much you want to contribute and estimate future costs based on current trends.
2. Invest in a 529 College Savings Plan
If you’ve never saved to put a child through college before, you may or may not be familiar with 529 plans. A 529 child college fund is an investment account that offers specific tax benefits when withdrawals are used to pay for qualified K-12 and qualified college expenses for a designated beneficiary.
529 plans are generally sponsored by state governments. Most states allow you to deduct contributions from your state income tax – and also don’t tax money that is withdrawn for college purposes. The state of California does not offer any deductions from state income taxes however.
Each state has its own unique 529 plan requirements and advantages, so it’s important to do your research and consider speaking with a qualified financial advisor. When opening a 529 account, you aren’t limited to your own state’s plan. If you live in Oregon but prefer California’s plan, for example, you can take advantage of that.
3. Open an IRA
While IRAs (individual retirement accounts) are typically used to save for personal retirement, they can also be used as college funds. When opening an IRA for your child’s education, you’ll want to consider the differences between a traditional IRA and a Roth IRA.
There are pros and cons to both of these types of accounts. However, Roth IRAs are funded with after-tax contributions, meaning that withdrawals are entirely tax-free. This makes them ideal for college savings if your yearly earnings fall under the Roth income limit.
4. Consider a Coverdell Education Savings Account
A Coverdell education savings account – often referred to as an ESA – is a tax-deferred trust account created by the federal government to help families pay for educational expenses. Beneficiaries with no special needs must be 18 years old or younger at the time the account is established, and these accounts carry maximum annual contributions of $2,000 per beneficiary.
An ESA can be used to fund elementary, secondary, and higher education costs, and the money doesn’t have to be designated for tuition only, but can also help cover room and board. In an ESA, funds can accumulate tax-free as long as they’re used for educational purposes and are distributed before the beneficiary turns 30 years old.
5. Buy Eligible Savings Bonds
Buying savings bonds from the U.S. Treasury is a low-risk and tax-smart strategy for college savings. Education savings bond programs allow qualified taxpayers to exempt interest earned from their annual gross income for tax purposes – as long as the funds are used for higher education tuition when you redeem them.
One benefit of this strategy is that savings bonds are guaranteed by the government, making them ideal for risk-averse savers. Unfortunately, earned interest tends to be lower than other types of investments. Additionally, funds must be used for tuition, and cannot be used to purchase textbooks or pay for room and board.
While they’re no longer issued in paper form, you can buy savings bonds conveniently at TreasuryDirect.gov.
6.Contribute to a Custodial Account
A custodial account is a fund issued in the name of a child, but is fully managed by their guardian or other adult until the beneficiary’s 18th birthday. Custodial accounts are a particularly flexible and easy-to-manage option, as there are no contribution limits and they can be invested through virtually any financial institution as long as decisions are made in the best interest of the child.
A custodial account is less expensive and easier to establish than other forms of generational wealth-transfer funds. They also offer significant tax benefits, as contributions are classified as the child’s income; however, this may also prevent the beneficiary from receiving financial aid upon their enrolment in school. Additionally, once your child turns 18, they assume full control over the funds, meaning that they may choose to not use them for their intended purpose.
Strategic, Individualized College Savings Planning with Chatterton & Associates
Saving for your child’s college education is an honorable thing to do. By planning ahead to ensure they’re in a financial position to pursue their goals and interests through higher education, you’re setting them up for success in life. There are many ways to save and it can be difficult to determine the best investments for your child’s college fund.
At Chatterton & Associates, we offer holistic, personalized financial advice and planning. We take the extra time to understand your unique financial circumstances, concerns, and goals so we can work together to build a comprehensive plan for your future – and the future of your family.
Our skilled, compassionate financial planners will work in coordination with our tax professionals and attorneys to ensure your college savings plan benefits you and your child now and in the future. Contact us today!
The Team at Chatterton & Associates
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc nor its representatives provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.