Ways to Save for College and Keep Student Loans at Bay
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If you have children, you already know college tuition is not getting any cheaper. That’s why it’s important to start saving for your child’s education as soon as possible. The earlier your start, the more likely you’ll have the funds needed to pay for their college expenses. Thankfully, there are many options to save money for your child’s college education, reviewed here.
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Ways to save for college
Coverdell Education Savings Account
A trust or custodial savings account, a Coverdell Education Savings Account (Coverdell ESA), is used to pay qualified higher-education expenses for the beneficiary. To qualify as a Coverdell ESA, the account must be established when the beneficiary is younger than 18 years old, unless they are a special needs beneficiary. In addition, the account must be designated as a Coverdell ESA when it is first opened, and the account terms must be in writing. A key benefit to a Coverdell ESA, the account is considered a parent asset on the Free Application for Federal Student Aid (FAFSA), so it won’t impact your child’s financial aid eligibility.
While funds are tax-free when used directly for your child’s college costs, there are some drawbacks to a Coverdell ESA. For instance, all contributions must be in cash, with a maximum contribution limit of $2,000 per year. Also, if you withdraw more than is necessary to pay college expenses, you’ll have to pay taxes on the excess. And, except for a special needs beneficiary, all Coverdell ESA funds must be withdrawn by the time your child is 30 years old.
In addition, there are income limits on who can contribute to a Coverdell ESA. For individuals, their income must be less than $95,000 to contribute the total amount. For individuals with an income between $95,000 and $110,000, contribution limits are lower. No individual with a payment of more than $110,000 can contribute. For joint filers, their income must be less than $190,000 to contribute the full amount. That amount is reduced for joint filers whose income is between $190,000 and $220,000. If their income exceeds $220,000, joint filers cannot contribute to a Coverdell ESA.
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- No origination fees, late fees, and no insufficient fund fees
- Flexible repayment options to help you find the right loan for you
- Student loans for college, graduate, law, MBA, Health Professionals, and Parent loans
- Students are 5x more likely to be approved with a cosigner
- 0.25% discount when you set up autopay
529 college savings plans
A tax-free savings plan, state-sponsored 529 college savings plans invest your savings in mutual funds, where the funds can, hopefully, grow more aggressively than they would in a traditional savings account. When it’s time to pay education expenses, the money can be withdrawn tax-free as long as it’s used to pay qualified college costs. These include tuition, fees, books, room and board, and computers and Internet access.
While you must select a state-sponsored 529 college savings plan, you don’t have to choose your state’s plan. You actually can — and should — shop around for a 529 college savings plan, looking for one with low or no fees. Once you find one you like, it’s important to set up the account in your name, not your child’s. Your child should be listed as the beneficiary on the account. This minimizes the impact on your child’s financial aid eligibility.
While there are no annual contribution limits to this plan, any contributions that exceed the annual gift tax exclusion could be attributed to your lifetime estate and gift tax exemption. For 2024, the annual gift tax exclusion is $18,000, while the lifetime estate and gift tax exemption are $13.61 million.
A bonus with this savings plan is anyone can contribute to it. Grandparents, aunts, uncles, friends — anyone can put money in this savings plan to help pay your child’s college expenses.
Interest-bearing savings accounts
A savings account is a good place to park money for your child’s education. However, you should look for a savings account with a high interest rate. Unfortunately, interest rates on savings accounts are not very high right now, but any additional earnings will add up. Plus, there is no limit on how much you can contribute to a savings account. While growth on savings accounts is primarily limited to how much you contribute, it’s still a good tool to save money for college.
Money market accounts
A bank account that blends features of both a checking account and a savings account, money market accounts are interest-bearing accounts that usually earn a higher interest rate than regular savings accounts. In addition, you can access the funds using the same tools as with a checking account: checks, debit cards, and ATM withdrawals. However, unlike a checking account, you most likely are limited on the number of withdrawals you can make within a specific time period.
Mutual funds
Mutual funds are investment accounts wherein your money is used to buy various stocks, bonds, and other investments. Growth can be quite aggressive in mutual funds, which means your money can multiply quickly. Given there are no contribution limits, this means you can increase your college savings much quicker than with some of the other savings tools listed here.
It’s important to note that you will have to pay income tax on all earnings in your mutual funds. In addition, if shares are sold in your mutual funds, you will have to pay taxes on any capital gains. And mutual funds will reduce your child’s financial aid eligibility.
Because they are dependent on how the stock market performs, there is risk associated with mutual funds. Therefore, it’s important to review the terms and conditions of mutual funds and their performance reports before opening any mutual funds accounts. If necessary, seek out the insights and advice of a financial advisor to help guide you through the various mutual funds.
Custodial savings accounts
Established under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA), you can open custodial savings accounts in your child’s name. There is no limit on contributions with these custodial accounts, although you should be aware of the federal gift tax limit of $18,000. If you contribute more than $18,000, you could owe taxes on that amount. While another option for college savings, there are drawbacks. For instance, when applying for financial aid, funds in these accounts must be reported on your applications, which can reduce your child’s financial aid eligibility. In addition, some earnings on these accounts are taxable, which can negate how much you save.
Roth IRA
Typically used as a retirement savings account (hence the name), a as well. The tax benefits for a Roth IRA include tax-deferred earnings and no withdrawal penalties, provided the funds are used to pay qualified higher education expenses. On the negative side, though, you cannot take a tax deduction on your income tax for any contributions, even though you are the only one who can make contributions to the account. There is a silver lining to a Roth IRA: Any funds not used to pay for your child’s college education can be used by you during retirement.
Eligible U.S. savings bonds
An often overlooked savings tool, U.S. savings bonds are a safe, secure way to build savings, albeit slowly. The earnings are not taxed when cashed, provided the funds go toward qualified higher education expenses. However, because the interest rates on savings bonds offer a low rate of return, you likely will be better off investing your money in one or more of the other savings tools listed here.
5.54% - 15.86% VARIABLE rate APRs 3.54% - 14.83% FIXED rate APRs
- Easy online application!
- No origination fees, late fees, and no insufficient fund fees
- Flexible repayment options to help you find the right loan for you
- Student loans for college, graduate, law, MBA, Health Professionals, and Parent loans
- Students are 5x more likely to be approved with a cosigner
- 0.25% discount when you set up autopay
Financial aid options
If you don’t have enough savings to cover your child’s college costs, there are options for receiving financial aid. The first step is filling out the Free Application for Federal Student Aid (FAFSA) form at studentaid.gov. Used by many states and colleges to determine which students receive assistance, FAFSA data is crucial to helping your child pay tuition at a public college or private school. Financial aid is provided in a variety of forms.
Grants
Grants are essentially free money. These funds do not have to be paid back unless your child does not meet the grant’s requirements. Numerous federal grants are available, including Pell Grants, Federal Supplemental Educational Opportunity Grants (FSEOG), Iraq and Afghanistan Service Grants, and Teacher Education Assistance for College and Higher Education (TEACH) Grants. Your state also may offer grants to help cover college costs.
Scholarships
Like grants, scholarships are free money that doesn’t have to be repaid, provided your child follows the guidelines for the scholarship. Scholarships typically are awarded based on either financial need or merit (academic, athletic, area of study, etc.). While colleges offer their own scholarships, scholarships are available through several other sources, including nonprofit and private organizations, corporations, and the military. Scholarship amounts vary from a few hundred dollars to the full amount needed to cover all four years of your child’s college expenses.
Many websites help students locate and apply for scholarships, but don’t end your search there. Talk with members of your community to see what local businesses, civic organizations, and other entities offer scholarships. Your employer also may offer scholarships, so don’t hesitate to ask and find out.
Student loans
Using your FAFSA data, the financial aid office at your child’s college will notify you of any student loans your child may qualify to receive. All federal student loans are administered through the William D. Ford Federal Direct Loan Program. The U.S. Department of Education acts as the lender and offers four types of loans: Direct Subsidized Loans, Direct Unsubsidized Loans, Direct PLUS Loans, and Direct Consolidation Loans. How much your student could receive depends on their school year and their dependency status. It’s important to review the terms and conditions of any student loan offers you receive and only to borrow the amount needed to avoid unnecessary student loan debt.
Work-study jobs
The Federal Work-Study Program allows your child to work part-time to earn money for their college expenses. Ideally, the goal is for students to work at a job related to their course of study. Jobs in civic education also are encouraged. This type of financial aid is not available at all colleges, so if this is an option you want to explore, check with your child’s preferred college to see if it participates.
How not to pay for your child’s college education
Faced with a shortage of funds to pay for the cost of college, it can be tempting to dip into your retirement savings, but that should be the last thing you do. Not only will this deplete funds in your retirement accounts you will need sooner rather than later, but you also could face paying penalties for withdrawing the funds early. In addition, the funds may be considered taxable income, further reducing the benefits of using these funds. If you take out a loan from your 401(k) and then leave that job, it’s possible you may have to repay those funds immediately.
Even if you can replace the funds in your retirement accounts, you may not get the same return on them in the long term that you would receive on the original amount. This is because there is less time for those funds to earn compound interest and grow. With so many savings options available, it’s best to leave your retirement savings untouched.
Related: How to Invest as a Teenager
5.54% - 15.86% VARIABLE rate APRs 3.54% - 14.83% FIXED rate APRs
- Easy online application!
- No origination fees, late fees, and no insufficient fund fees
- Flexible repayment options to help you find the right loan for you
- Student loans for college, graduate, law, MBA, Health Professionals, and Parent loans
- Students are 5x more likely to be approved with a cosigner
- 0.25% discount when you set up autopay
The bottom line
For most people, saving for your child’s college education will likely occur over the long term. Finding the right savings tools to make the most of your money throughout those years is crucial. While Coverdell ESAs and 529 college savings plans are ideal for saving for college, interest-bearing savings accounts, money market accounts, mutual funds, custodial savings accounts, Roth IRAs, and even U.S. savings bonds could be good accompaniments for additional savings. If necessary, your student could apply for and possibly receive financial aid in the form of grants, scholarships, and student loans to help pay for college.
When setting up your savings tools, check each one out to see which ones are the best fit for your needs. A financial advisor may also guide you to the best savings tools for you.
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Writer
Karon Warren is a freelance writer who has covered articles in finance, insurance and health for sites like Reviews.com, USA Today, Healthgrades, among others.
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