Setting money aside for your child's education can be an effective way to pay for sizable tuition, room and board, and other miscellaneous education expenses. According to the College Board, the average price for a private college for the 2013-2014 school year was $31,231; the cost for state residents are public colleges $9,139; the cost for out-of-state students at public colleges $22,958.
Because of the compounding value of money, the earlier you start saving for your child's education, the more of a chance the money has to grow. It's important to keep in mind that in almost all cases, if the child or parent wants to maximize financial aid, any money saved should be done in the parents' or grandparents' names.
The information below shows the most common savings techniques used by those savings for college according to a survey done by Fannie Mae and some helpful information about each of them.
Savings Accounts
Used by 45% of those saving.
FDIC Insured accounts offered by banks and credit unions.
Pros:
- Easy to open
- Money is FDIC insured.
- Some modest interest on high yield accounts.
- Money very liquid and easy to withdraw.
Cons:
- Interest is relatively low right now.
- Money does not grow that quickly.
- Income is taxable.
Who Is this For:
Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some interest on their savings.
How to Open
You can open a savings account at a bank or credit union. BestCashCow can help you find the best rate from a local bank or an online bank.
529 College Savings Plans
(Used by 29% of those saving)
Education savings plan set up by state or educational institution that grow Federal tax-free and can be distributed tax-free. The plan may also offer some state tax benefits. Generally, each state has its own 529 plan.
Pros:
- Income grows Federal tax-free.
- No taxes on distribution as long as used for qualifying educational purpose.
- Donor retains control of funds.
- Low maintenance as the plan takes care of managing the portfolio.
- Up to $300,000 per beneficiary allowed in most state plans.
Cons:
- You must use the money for college or there is a 10% penalty on withdrawal.
- Fees can be higher than no-load mutual funds.
- 529 performance is not guaranteed.
- The funds can and have lost money.
Who this is for:
529 Plans are good for parents of younger children who have 5+ years to go before they attend college. This allows them to ride out any downturn in the market. The plans are also good for parents who want to take advantage of the tax advantaged nature of the plans.
How to Open:
You can open a 529 Plan through a brokerage.
Checking Accounts
(Used by 24% of those saving.)
A deposit account at a bank or credit union that allows the user to withdraw money using checks, debit cards, ATMs, or other electronic means. Usually does not pay high interest.
Pros:
- Easy to open
- Money is FDIC insured.
- Some modest interest on high yield checking accounts or online checking accounts.
- Money very liquid and easy to withdraw.
Cons:
- Interest is relatively low right now. Money does not grow that quickly.
- Income is taxable.
Who This is For:
Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some interest on their savings.
How to Open:
You can open a checking account at a bank or credit union.
Find the best checking account rate.
Investments
(Used by 20% of those saving)
Stocks, bonds, and mutual funds not included 529 Plans or 401K plans.
Pros:
- Total flexibility in choosing investment options.
- May have higher return than bank-based investment accounts.
- Money can be withdrawn and used for any purpose.
Cons:
- Money is taxable.
- Investments can lose value.
Who this is for:
For students and parents who want a higher rate of return than what is provided by a bank account but might also use the money for purposes other than college expenses.
How to Open:
A brokerage account allows you to deposit money and invest. View our list of brokerage accounts.
Retirement Accounts
(Used by 18% of those saving)
Retirement plans such as Roth IRAs, 401K plans, and regular IRAs.
Pros:
- Roth IRA plans allow the money to be withdrawn penalty and tax free after the age of 59 1/2.
- Other IRA plans allow penalty free withdrawal if the money is used for education, but taxes must be paid on the earnings.
- If you borrow from a 401K, the money is not counted on the FAFSA.
Cons:
- Money is taxable.
- Investments can lose value.
Who this is for:
For students and parents who want a higher rate of return than what is provided by a bank account but might also use the money for purposes other than college expenses.
How to Open:
Employee sponsored plans can be opened at work. Non-employee plans can be opened and funded via a brokerage company or financial company.
Certificates of Deposit
(Used by 16% of those saving)
FDIC insured instruments in which the depositor agrees to leave the money in the bank for a set period of time in return for a set rate of interest over that period.
Pros:
- Safe. Certificates of Deposit from FDIC insured banks are considered to be a very safe investment.
- Generally higher interest than a savings or checking account.
Cons:
- The money is not very liquid during the term of the CD ( a user can break the CD and withdraw money by incurring a penalty.)
- Current interest rates are low by historical standards.
- Income from CDs is taxed.
Who this is for:
Students who are two or three years away from college and cannot afford to lose money in the stock market but want to earn some interest on their savings. Or, parents who do not want to take the risk of investing education money in the stock market.
How to Open:
You can open a CD at a bank or credit union. Find the best rate from a local bank or an online bank.
US Savings Bonds
(Used by 15% of those saving)
Bonds issues by the Federal government that pay interest.
Pros:
- Savings bonds are extremely safe, backed by the full credit of the U.S. government.
- Income from savings bonds can be excluded if used to pay for college (note this is not available to higher earners. Read more).
- If bonds are in the parent's name, it will have a low impact on financial aid eligibility.
Cons:
- Interest on savings bonds is low, even compared to CDs and savings accounts.
- For higher-income families, savings bond income is Federal, but not state taxable.
- Savings bonds must be held for at least 5 years or a penalty of the last three months of interest.
Who this is for:
With current interest rates, there is no reason for anyone to use Savings Bonds as a college savings vehicle.
How to Open:
Savings Bonds can be purchased directly from the US Treasury website.
Coverdell Accounts
(Used by 13% of those saving)
Tax-advantaged accounts similar to 529 plans that help saver for education expenses. The money can be used for K-8, high school, or college.
Pros:
- Money can be used for elementary, high school, or college expenses.
- Money grows tax-free.
- Investments are self-directed allowing more flexibility in choosing options.
- Money in the child's
- If funds are in the parent's name, funds will have a low financial aid impact.
Cons:
- There is a maximum contribution limit of $2,000 per student per year.
- Income limit of $95-$110,000 for single tax-payer and $190,000 - $220,000 for married couple filing jointly.
- If the account is in the child's name, fund in the account will have a high impact on financial aid treatment.
Who is this for:
The Coverdell plan is for parents who might want to use the funds for private elementary, high school, or college, who like to control what the money is invested in, and who earn below the max-income guidelines.
How to Open:
Many financial services companies offer Coverdell Accounts.
