Understand the different saving vehicles to help stay ahead of rising education expenses and help reach your goals.
There are a wide array of options to save for college, but choosing one for your family will depend on your priorities, time horizon, long-term goals and tax situation.
We can help you evaluate the different possibilities and develop a saving strategy that makes sense for you and your other long-term goals.
Here’s what to consider as you choose an appropriate saving vehicle for your situation.
In this article
- Estimate costs and set your savings goal
- Understand different college savings options
- Tax-advantaged savings options
- 529 plan
- Coverdell Education Savings Account
- Cash-value life insurance
- Other college savings options
- Brokerage accounts
- Savings accounts / CDS
- Retirement accounts
- Implement your plan
- Questions to discuss with us
1. Estimate costs and set your savings goal
Understanding the overall cost of your student’s education experience, including their lifestyle expenses, may give you a target to strive for, and help you determine which saving vehicle fits your goals. The number doesn’t have to be exact. You can always change the goal as your child’s interests and aspirations evolve. Consider using our college savings calculator to determine how much you may need to start saving.
Learn more: Financial planning for college: What to know before you start saving
What are your college savings options?
Saving for college is one of life’s biggest financial goals. With numerous savings options to consider, it’s important to choose one that aligns with your unique situation and other long-term goals. Learn about three common tax-advantaged solutions to help you weigh your options.
2. Understand different college savings options
As you save for your student's college education, your strategy may include one or more savings vehicles, depending on your situation. There are different tax implications and considerations for each option.
Tax-advantaged options
When saving for college, there are certain accounts that can provide your family with tax benefits.
529 plan
One of the popular options to save for college is a 529 plan, which is a tax-advantaged account primarily intended for higher education expenses.
A 529 plan allows an individual to contribute after-tax money into an investment account on behalf of a designated beneficiary. Almost all U.S. states offer a 529 plan, and investors are generally free to shop around for a plan that works for them, regardless of their residency status.
Here are some pros and cons:
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Pros
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Cons
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- Contributions grow tax-deferred, and withdrawals are tax free as long as they are used for qualified education expenses, which include tuition, room and board, books, and fees.
- Convenient way for extended family to contribute: Allows a parent, grandparent (or almost anyone) to invest money on behalf of the plan’s specified beneficiary (typically a child or grandchild).
- No income limits: No income constraints on account owners.
- No age limits: Beneficiaries can be any age.
- Flexibility and control over beneficiaries: The owner can easily change the beneficiary to transfer unused assets.
- Potential for additional state tax benefits: Some states offer additional tax benefits if residents use their 529 plan.
- Can move unused funds into a Roth IRA: Beginning in 2024, certain unused funds in 529 plans that are at least 15 years old can be transferred to the beneficiary’s Roth IRA. The transfer is subject to a lifetime maximum of $35,000 and the beneficiary’s annual IRA contribution limit and the beneficiary must have annual income equal to or greater than the contribution amount.
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- Only cash contributions are accepted: You can't contribute stocks, bonds or mutual funds.
- Impact on financial aid: Contributions and distributions may affect need-based financial aid.
- Fees: Annual expenses and fees for maintaining the accounts can add up.
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Bottom line: A 529 plan can be a powerful college saving vehicle. There are many reasons why these are a popular account for education goals, but it’s necessary to understand how it works before you can take full advantage of it.
Learn more: 529 plans: Frequently asked questions
Coverdell Education Savings Account
Formerly known as an Education IRA, a Coverdell Education Savings Account (ESA) is a college savings option similar to a 529 plan in that contributions grow tax-deferred — but come with more limitations.
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Pros
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Cons
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- Contributions grow tax-deferred, and withdrawals are tax free at the federal level if they are used for qualified education expenses, which include tuition, room and board, books and fees.
- Investment options: There are generally more investment options available with a Coverdell than with a 529 plan.
- Withdrawals can be used toward private school tuition, tutoring and computers, tax-free: The child must use the funds before age 30 unless they are a special needs beneficiary.
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- Smaller contribution limit: Families can only contribute a maximum of $2,000 per year per child to an ESA.
- Income limits on the account owner: To contribute to a Coverdell account, you must make under a certain income threshold set by the IRS.
- Age limit on beneficiaries: Contributions to the account must generally be made before the beneficiary turns 18.
- Limited withdrawal window: Any assets in the account must be withdrawn before the beneficiary turns 30 unless the beneficiary has special needs.
- Impact on financial aid: Contributions and distributions may affect need-based financial aid.
- Fees: Annual expenses and fees for maintaining the accounts can add up.
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Bottom line: A Coverdell ESA can be a useful vehicle, but it offers less flexibility and savings potential than a 529 plan.
Cash-value life insurance
The purpose of life insurance is to provide a sum of money at the death of the insured. However, it can be used for many purposes such as part of your college funding strategy. With a cash-value life insurance policy, a portion of your premiums goes toward a death benefit and another portion is allocated into a cash-value account. When properly structured, you can take out an income tax-free loan against your cash value to pay for school.
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Pros
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Cons
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- Not counted by the FAFSA: Life insurance is not counted as a parental asset in the Free Application for Federal Student Aid (FAFSA).
- Flexibility with cash value: The policy’s cash value can be used for any costs — not just qualified educational expenses. For example, it can be used to pay down consumer debt as you’re saving for college or help pay off student loans later.
- Low-interest and tax-free loan: You’re able to borrow against the cash value of the policy.
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- Impact on death benefit and cash value: Taking a loan against the cash value can affect the net death benefit and may cause a permanent reduction of cash value.
- Affordability: It may not be the most affordable option for saving since it can take time for the cash value to outgrow the cost of premiums.
- Impact on policy. If the loan isn’t repaid, the accruing interest could erode the cash values and result in a policy lapse with some types of policies.
- Fees: Annual expenses and fees for maintaining the accounts can add up.
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Bottom line: Permanent life insurance can offer investors an alternative way to pay for their student’s educational expenses. But college savings shouldn’t be the primary goal when deciding whether to open a policy.
Other college savings options
In addition to the above vehicles, below are a few other college savings options. For brokerage or savings accounts, you could set up an account dedicated to each student you are saving for, if you choose.
Please note: These options don’t have the same tax advantages as the accounts mentioned above and generally aren’t as optimal for college saving goals.
Brokerage accounts
The biggest benefit of using a traditional investment account to fund your child’s college is the flexibility and freedom it offers. These accounts don’t have limitations on how you spend your assets, what funds you can invest in or how much you can contribute.
However, you won’t receive any of the tax advantages if you were to use a 529 plan or Coverdell ESA. Instead, after-tax dollars fund brokerage accounts, and withdrawals are taxed as capital gains.
Bottom line: Using traditional brokerage accounts to save for your child’s education does not offer tax efficiencies. However, these accounts leave more flexibility for use of the funds than tax-advantaged college savings options. If you are willing to forgo potential tax savings in favor of more flexibility, then a brokerage account may be a good option to include in your strategy.
Savings accounts/CDs
While traditional savings accounts and certificates of deposits (CDs) may keep your money out of the market and can be lower risk, their earning potential doesn’t make them an ideal long-term college savings option for parents seeking to pay big expenses, such as tuition. Generally, the rate of return on these types of accounts doesn't keep pace with inflation or rising college expenses.
In many cases, these accounts are better used to build a cash reserve and save for less significant college costs that have a shorter time horizon and don’t count as a qualified higher education expense. For example, if your child is a year out from college and you want to help furnish their dormitory, a savings account may be a smart place to accumulate funds for that short-term goal.
Bottom line: Savings accounts and CDs don't provide the same opportunity for long-term growth as investment options, however, as you get closer to your student’s college years, savings accounts and CDs can be helpful vehicles to keep your money liquid for smaller expenses.
Retirement accounts
If you withdraw from a 401(k) or an IRA to fund your child’s college costs, you may be subject to additional costs, such as income tax or early withdrawal fees, and you could also impact your future retirement income. Overall, using a retirement account is generally not advisable to save for a child’s college expenses, but a Roth IRA does offer you the freedom to do so if it makes sense for your unique situation.
Bottom line: When it comes to balancing retirement and saving for college, retirement should be your priority. Remember: You can’t get a loan to fund your retirement years.
3. Implement your plan
Once you’ve settled on the college savings options that work for you, it’s time to open your preferred account and start saving to help reach your education goals.
Let’s talk through your options
We can help weigh the pros and cons of various college savings options and make a recommendation aligned with your other goals and financial situation.