College Funds for Kids: Find the Right One for Your Family

Every parent dreams of the day when their child walks across the stage to accept his or her college diploma. But every parent also knows that getting them there will require paying for school. While some students are able to fund their education through scholarships, fellowships and grants, most parents may need to chip in for education. 

Creating a college fund for kids often begins when your child is still young, but many parents are not sure where to start. You may be wondering how to open a college fund, how much a college fund should be or which savings option makes the most sense for your family.

Understanding the benefits of saving for college now can help save you thousands later. Here are some basics of how to start saving for your child’s college fund.

Education Savings Account (ESA) vs. 529: The Basics

A tax-advantaged college savings plan can help your hard-earned money go farther. Two of the most popular college funds for kids — the 529 Plan and the ESA — are designed to finance your child’s higher education and save money, too. 

529 Plan

A 529 is a state-sponsored plan that offers tax-advantaged investments to cover the cost of higher education (and certain K-12 expenses as well). With a 529 plan, a parent, grandparent or other person can open the account and make contributions on behalf of a beneficiary, and that money is then invested based on choices allowed by the particular 529 plan chosen. 

Each state offers at least one 529 plan. The costs of plans and their investment selections differ from state to state. Additionally, it’s possible to invest in a plan in another state if you find one that better fits your needs.

Maximum Contributions: Each state’s 529 plan establishes its own contribution limits. The maximum lifetime contributions can range from $350,000 to $500,000 per student. 

Qualified Expenses: Funds can be spent on qualified tuition, fees, room and board, books and supplies for higher education students. Families can also opt to use the 529 resources for a qualified apprenticeship and eligible homeschool expenses, as well as limited student loan repayment. For K-12 education, funds can be applied toward the cost of qualified tuition and fees. 

Restrictions: There are no time or age limits on a 529 college savings plan, which can make it a useful fund for people who want to take a less-conventional route to college. Funds in a 529 account will never expire. If the money is not used for education, it can be rolled into a Roth IRA for the original intended recipient.

Income Restrictions: There are no income limits for 529 plan contributions.

Available Investments: Each program has its own investment strategies. Some offer the flexibility to choose investment portfolios, while others direct funds in a single portfolio.

Federal Coverdell Educational Savings Account (ESA)

The ESA is a tax-advantaged investment used to fund education. An ESA is similar to a 529 plan but typically comes with more limits and restrictions. It allows for tax-free growth and tax-free withdrawals. ESAs can be used for K-12 expenses as well as higher education. 

Maximum Contributions: The maximum yearly contribution for an ESA is $2,000 per year, from birth to age 18.

Qualified Expenses: Funds can be used to cover tuition, fees, books, computers and other supplies. They can also be used for room and board for students enrolled at least part-time.

Restrictions: Contributions must be made before students turn 18. Funds must be used before age 30, but they can also be rolled over to another ESA for a different family member.

Income Restrictions: Accounts are only available to couples with modified adjusted gross incomes of less than $220,000 (or $110,000 for single filers).

Available Investments: You can choose the investments within the ESA portfolio and transfer funds between different investments within the company.

Tax Implications

For both 529 plans and ESAs, contributions are not federally tax-deductible, although many states do offer a tax deduction for contributions. However, the investment earnings and withdrawals for qualifying educational expenses are tax-free.

The contribution is considered a gift for tax purposes, which means that to avoid the gift tax, it cannot exceed the limit, although under certain rules, you can make a one-time contribution without incurring taxes for the gift.

Impact on Financial Aid

Funds for both types of plans are considered assets of the parent or the account owner. That means that they may be included in the calculation for other kinds of financial aid that could be offered by the school. Consult with your financial professional for guidance on how this may affect eligibility in the future. 

Withdrawal for Non-Educational Expenses

For both types of plans, funds withdrawn for non-educational uses are subject to federal tax and a penalty of 10 percent for non-qualified expenses. It’s best to plan to only use the funds for qualified educational expenses and plan accordingly. You’re saving for your child’s education and future.

Take the Guesswork Out of Saving for College

The best way to ensure you’re making the right investments for your child’s future is to talk with a professional and make sure you are ready for the financial impacts of college.