Saving for College: What You Need to Know

A college degree doesn't come cheap. Still, it's an important investment in yourself or your child's future. The best way to help prepare financially is to start saving now and try to avoid any financial problems for your future college student. 

Whether college is fast approaching or you're planning ahead for your young children, here's a start on what to know about saving for college. This guide will help you make informed decisions as you work toward your college savings goals.

Exploring College Savings Plans: Your Options

In order to start effectively saving for college, it's important to understand your options. Learn more about some of the most common college savings plans.

529 Plans

These investment accounts are a popular way to set aside money for college. Parents often open 529 plan accounts for their children. A 529 college savings plan is defined as a tax-advantaged investment account designed to encourage saving for future education costs.

Depending on the 529 plan rules of the account, which vary by state, you may be able to take a tax deduction for some or all of your contributions. Other people can also contribute to 529 accounts, including grandparents. The money in a 529 account can be used toward qualifying expenses, ones such as tuition, fees, textbooks, room and board and studying abroad. 529 Savings Plans are investments subject to market risk. You could lose some or all of the principal amount invested.

Just take note: prepaid tuition plans can only be used to pay for tuition. A 529 plan may also impact financial aid eligibility. Plus, you could owe fees on unused funds.

Coverdell Education Savings Account (Coverdell ESA)

A Coverdell ESA is a trust or custodial account, where you set aside funds for certain qualified education expenses.¹ The money can be used toward elementary and secondary education, as well as for college. Contributions are not deductible, but distributions to beneficiaries are generally tax-free.

Uniform Transfers to Minors Act (UTMA) & Uniform Gifts to Minors Act (UGMA)

UTMA and UGMA both led to laws enabling donors to make certain tax-free gifts to minors.² Such gifts can be a useful tax-advantaged strategy for saving for college, especially if grandparents or other family members wish to make a direct cash gift in support of a child's future college expenses.

Under the UGMA, gifts can only be made using cash or securities. The UTMA extended that law by allowing donors to transfer any kind of property to benefit a minor. When the minor reaches the legal age in their state, they gain access to the gift or property that was transferred to a custodian on their behalf.

CDs and Mutual Funds

Don't overlook traditional investment and savings accounts as you piece together your college savings strategy. Work with a financial professional to review options such as mutual funds and certificates of deposit (CDs). A professional can help you pinpoint investments suited for your timeline and your savings goals: A riskier investment with higher growth potential might make better sense for a saver with young children, for example. A lower-risk, lower-return option might be better for the parents of a high school senior.

How to Determine Your Course of Action

There is no one-size-fits-all approach to saving for college. Many people mix and match different strategies and vehicles, depending on their goals, potential tax advantages and other priorities. Consider these factors as you decide among your options.

How Much Do You Intend to Save?

Your savings goal depends in large part on your education goals. For example, a program at a trade school, community college or online degree program might be shorter and more affordable than a four-year university. If you're going back to college as an adult, you may need to save more money in order to cover lost wages, or you may want to consider a longer-term program that you can pursue as you continue to work.

Once you have an idea of your educational goals, start researching the cost of your preferred programs. Research not just tuition prices but also the cost of room and board, books, fees, travel expenses and other associated costs. If you're saving for a child who is many years away from college, factor in the impact of inflation. Tuition at public four-year institutions, for example, increased on average by 31.4% from 2010 to 2020, according to the Education Data Initiative.⁴

By better understanding how much you need to save, you'll be better equipped to determine which plans address your needs.

Tax-Advantaged Accounts

A tax-advantaged account is one that either allows you to make tax-deductible contributions, and/or it allows money in the account to grow tax-free, meaning you won't later owe taxes on distributions.

Tax-advantaged accounts include 529 plans, Coverdell ESAs and certain savings bonds.

Federal Tax Benefits

The Internal Revenue Service (IRS) offers several tax benefits to help offset the cost of higher education. If you save with a Coverdell ESA, for example, money taken from the account to pay for qualified education expenses is distributed tax-free.

There are also two tax credits you may be eligible to take for your dependents in college or career school. They include the American Opportunity Credit, worth up to $2,500 per student per year for their first four years of school, and the Lifetime Learning Credit, worth up to $2,000 per student per year.⁵ A tax credit of up to $2,500 per year is also available to deduct the interest paid on student loans.

State Tax Benefits

Each state administers its own 529 plan. Many plans allow savers to deduct plan contributions on their state income tax returns. The rules vary by state, so look into your state's 529 plan options to see what tax benefits may be available to you.

Planning for Other College Expenses

The cost of college doesn't stop at tuition and books. Other small expenses can quickly add up, including transportation to visit home on weekends or holidays, laundry, storage and entertainment. Students living on campus should also consider summer storage and moving costs. Consider whether you will budget to help cover these expenses for your child or if your child should plan to work during college to help pay their way.

Tips to Complement College Savings

In addition to saving for college, you can also unlock college funding opportunities through financial aid, scholarships, grants and other opportunities.

Financial Aid

Anyone pursuing college or graduate school should complete the Free Application for Federal Student Aid (FAFSA) form.⁶ By completing this form, you can apply for many forms of federal student aid, including grants and loans. Schools may also use the information from your FAFSA form to determine eligibility for additional aid.

Before you start filling out the FAFSA form for yourself or your child, make sure you're prepared with all of the forms and records you need.⁷ Be mindful of the deadlines for submitting your form: There may be different deadlines to apply for federal aid versus state aid.⁸

Grants

Grants are generally awarded based on financial need, Unlike loans, they don't need to be repaid except in rare circumstances, such as dropping out of the program for which you received a grant.⁹

Scholarships

Scholarships are generally awarded based on merit or academic achievement. Many higher education institutions offer scholarships to students in specific fields of study, or students from certain backgrounds, such as first-generation college students. Many other private donors and organizations offer a variety of scholarships. Consider searching for scholarships through a high school guidance counselor, the College Board and in your local community.¹⁰

College Credit During High School

When students earn college credit in high school, they have a leg up when they arrive to college. Not only are they better prepared to handle college-level coursework, but they can also start their higher education journey with course credits that count toward graduation. This often translates into savings on tuition and fees.

See if your child's high school offers dual-enrollment classes in collaboration with a local college or university system. Such classes allow high schoolers to take certain courses, either at a local college or in their regular high school classrooms, and earn college credit while completing high school requirements. In many cases, the college credits they earn are transferrable to four-year colleges and universities.

High schoolers can also earn college credit by taking Advanced Placement (AP), International Baccalaureate (IB) or Cambridge Advanced International Certificate of Education (AICE) classes and performing well on corresponding exams. Every school has different rules about awarding college credits based on AP, IB and Cambridge AICE exams. So it's a good idea to look into your preferred schools' policies to understand which courses may qualify for college credit.

Loans As a Last Resort

Student loans are another option for paying for college. When you fill out the FAFSA form, you may receive an offer to take out federal student loans as part of your financial aid package. Federal loans may be either subsidized or unsubsidized: Unsubsidized loans accrue compound interest while the student is in school, and subsidized loans do not accrue interest until after the student graduates. Parents also may be offered PLUS loans to help pay for their child's undergraduate education.

If you aren't eligible for federal student loans, you can pursue private student loans through banks and other financial institutions. Private loans generally have higher interest rates and less favorable terms.

Smart College Savings Strategies to Consider

Follow these tips to help you prepare for when the time comes to pay for higher education.

Start Early

It's never too early (or too late) to open a college savings account for your child. The sooner you start saving and investing, the more time your money has the potential to grow. Even saving a few dollars a week can grow to a significant amount over time.

Automate Contributions

Taking a set-it-and-forget-it approach to college savings can help keep you accountable and on track to reach your savings goals. See if your college savings account offers automatic transfers from your savings or checking account. Consider how much you want to save over the course of the year, then divide that number to determine how much you should set aside each month or each week via automatic transfer.

Reevaluate Investment Allocations

Your investment strategy will likely look different if you're saving for a newborn than if you're saving for a high school senior. As your child gets older, keep a close eye on your investment allocations to be sure you aren't assuming too much risk close to when you'll need to access your savings. A financial professional can help you determine allocations suited for your goals and your timeframe.

Monitor Progress

Keep a regular eye on your college savings plan. Stay aware of your progress and position in the market. By using a mix of college savings plans and investment strategies, you can potentially help mitigate risk and diversify your savings.

Bottom Line

Higher education is one of the largest investments you will make in yourself or your child. By taking the time to understand how to save for college, how to pay for college, identify your goals and keep close tabs on your investments, you can move forward with confidence that you will be able to fund some or most of your education expenses in the future.

Whether you're starting to save for a young child or the time to begin college is fast approaching, it's never too late to make the most of college savings accounts and reap the potential tax benefits. For more information, consider reaching out to a financial professional who can offer personalized guidance based on your individual needs.

Sources

1. Topic No. 310, Coverdell Education Savings Accounts. https://www.irs.gov/taxtopics/tc310.
2. SI 01120.205 Uniform Transfers to Minors Act. https://secure.ssa.gov/poms.nsf/lnx/0501120205.
3. Using bonds for higher education. https://treasurydirect.gov/savings-bonds/tax-information-ee-i-bonds/using-bonds-for-higher-education/.
4. College Tuition Inflation Rate. Education Data Initiative. https://educationdata.org/college-tuition-inflation-rate.
5. Did you know that the Internal Revenue Service (IRS) provides tax benefits for education? https://studentaid.gov/resources/tax-benefits.
6. 2023–24 FAFSA® Form. https://studentaid.gov/h/apply-for-aid/fafsa.
7. Filling Out the FAFSA® Form. https://studentaid.gov/apply-for-aid/fafsa/filling-out.
8. FAFSA® Application Deadlines. https://studentaid.gov/apply-for-aid/fafsa/fafsa-deadlines.
9. Federal grants are money to help pay for college or career school. https://studentaid.gov/understand-aid/types/grants.
10. Search for Scholarships. https://bigfuture.collegeboard.org/pay-for-college/scholarship-search.