There are several ways to set up a college savings account for your baby, from 529 savings accounts and Coverdell ESAs to more general savings and investment accounts, such as Individual Retirement Accounts. Let’s look at some of the best college savings accounts and how to set one up for your little one because the earlier you start saving for college, the better.
If you’re ready to open your child’s account, consider the best 529 plans available today.
Why a New Baby Needs a College Savings Account
Sending your child to college is an investment that will help them build a successful, well-paid career: college graduates are better paid and less likely to be unemployed. However, you need a way to finance that investment. If your child tries to finance it themselves, even a part-time job can pull their focus from their studies and threaten that investment, not to mention that college costs have long been rising much faster than wage growth.
Equally, taking out loans could give your child a massive burden of student debt and is far more expensive in the long term than paying for college with savings. Financial aid can help, but you can’t rely on your child being able to secure enough financial aid to cover growing higher education costs, especially as the total amount of federal aid has declined every year over the past decade.
The best solution is almost always to set up a tax-advantaged college savings account as early as possible.
The Costs of Going to College
College can be very expensive. Tuition can vary greatly depending on the school, especially if your child wants to attend a renowned private institution. However, even public schools can have annual tuition of $20,000 for out-of-state students, so over the course of a four-year degree, a student today can easily spend over $100,000 in tuition, room and board, supplies, and fees.
In addition to tuition, you’ll also need to cover institutional fees, room and board, and a range of other costs associated with your child’s tertiary education.
Furthermore, the cost of college will likely increase over the next 18 years until your baby is ready to go to college. Between 1980 and 2020, the average cost of an undergraduate degree rose by 169%, and the odds are that this growth trend will only accelerate.
The earlier you start your child’s savings account, the better, as compound interest and tax benefits can add up over time, significantly reducing the total amount you’ll end up paying for college.
Therefore, while it may seem premature to already be planning for your new baby’s college expenses, this is the best thing you can do to secure their future education without putting you – or them – under financial stress.
Why Choose a 529 Plan for a College Fund?
There are multiple types of college savings accounts, including education-specific accounts such as 529 savings plans and Coverdell ESA plans, as well as IRA and savings accounts. This can be one of the most confusing things for new parents who want to plan for their child’s future, as each type of savings account has its own distinct benefits and advantages. Your choice will depend on your family’s situation and future plans.
529 plans are tax-advantaged accounts designed to help you pay for your child’s primary, secondary, or college education. The most common type of 529 plan is the 529 savings program, sometimes called college savings plans (CSPs) or college investment plans (CIPs).
When you open a 529 savings account, you name a beneficiary, such as your baby, and make contributions, which are then invested on their behalf. When the beneficiary goes to college, they can use these funds to make qualified distributions, such as paying for tuition, fees, and room and board.
Note that there is also a second type of 529 plan, prepaid 529 plans, which offer tax advantages similar to 529 savings plans but work slightly differently. These plans allow you to pay in advance for certain credit hours or semesters at a specific university and lock in tuition rates, usually an in-state public school. Take a look at this guide to 529 prepaid programs to learn more.
Pros of 529 plans
Some advantages of 529 plans include:
- Various federal and state tax advantages, including tax-free withdrawals for qualified education expenses
- Flexible: you can change the beneficiary to another qualifying family member at any time
- Generous contribution limits, so you can invest as little or as much as you can afford
- State-sponsored and professionally managed
- Allow you to maintain ownership over the 529 accounts, so you control when money is withdrawn and for what purpose.
Cons of 529 plans
Some potential downsides of 529 plans include:
- Any funds used for non-qualified expenses will be subject to ordinary income tax and a 10% penalty.
- More limited control over how your money is invested compared to other investment types, as the state and the investment manager determine this, they appoint
- Investment or program management fees apply, though these are usually modest.
Tax advantages
One of the significant benefits of 529 plans is their tax advantages. Regarding federal income tax, the money you invest will grow tax-deferred, and you can withdraw funds for qualified expenses tax-free. You cannot deduct contributions on your federal income tax return, but you can defer paying tax on these, allowing you to compound your earnings.
You could get a break on your state taxes, too. More than 30 states and the District of Columbia offer state income tax deductions and tax credits for 529 plan contributions.
How to Open a College Savings Account for Your Baby
Do you know what type of savings account you want to set up for your baby’s college fund but are unsure where to start? Let’s look at how to open a college savings account, using a 529 plan as an example.
Step 1: Choose a 529 Plan
The first thing you need to do is decide the best 529 plan for you. The range of choice may seem overwhelming, so start with the 529 plans offered by your state, as they may offer benefits for residents, such as state income tax deductions on contributions.
It’s also a good idea to consider the 529 plans offered by other states: each state has its own plan, and you don’t need to be limited to the state where you live or where you think your child will go to college. Your baby can still use the money to go to college anywhere. Instead, it’s essential to consider factors such as whether investment options match your investment objectives and preferred level of risk, how well the investment portfolios have performed in the past, and the plan’s specific rules and restrictions.
Step 2: Determine the Type of 529 Account
Next, you must decide which type of 529 accounts you want to open.
There are two different types:
- Individual accounts: This is a regular 529 plan account in which an adult, usually a parent, but sometimes a grandparent, another family member, or friend, is the account owner, and the student is the beneficiary.
- Custodial accounts: In this type of account, the student is both the account owner and the beneficiary. If the student is a minor, the account will be managed by a designated custodian until they turn 18.
Generally, when setting up a 529 savings account for your baby, it will make the most sense to open an individual account with you as the account owner and your baby as the beneficiary. Note that typically, only one parent can be named the account owner.
Step 3: Complete a 529 Application
Once you’ve compared a range of 529 plans and decided which is the best for you, it’s time to open an account.
Visit the Enroll Now tool and follow these steps:
- Find the plan you want and click on the “enroll now” button next to its listing
- Once the online application loads, fill in the account owner’s and beneficiary’s names and personal information, such as Social Security numbers and dates of birth.
- Sometimes, you’ll need to pay a fee to submit your application.
You can also complete an application by visiting the 529 plan’s website.
Step 4: Fund the Account
Many 529 savings plans require you to make an initial contribution to kick off your plan. In any case, you’ll want to start making contributions as early as possible to maximize the returns on your investment.
You can do this in various ways, from transferring money electronically to mailing a check to the program administrators. All 529 plans also allow you to set up automatic contributions, a great way to ensure you continue to fund your account.
Also, don’t forget that anyone can contribute to a 529 plan, not just parents or the account owner.
Step 5: Choose Your Investments
Once you’ve opened and funded your 529 accounts, you can choose the type of investment portfolio you want from a limited range of options, usually categorized according to risk profile.
Many people opt for an age-based portfolio that begins with a higher-risk, higher-return mix of investments and shifts to a lower-risk investment profile as their child gets closer to going to college.
Tips for Opening a College Savings Account for Your Baby
Regardless of your child’s age, it’s never too early to consider saving for college. While it isn’t always an easy-to-understand thing to do, there are plenty of opportunities. Here are a few tips to keep in mind when saving for your baby’s college education to help you get off to a good start:
- Automate your savings as much as possible, such as setting up automatic investment options and contributions to your 529 plan.
- Minimize your tax by taking advantage of all possible tax advantages associated with your baby’s college savings account, and speak to a tax account if in doubt.
- Consider Coverdell ESAs for private schools: If you plan to send your child to a private elementary or secondary school, it could be worth investing in a Coverdell ESA. You can always use any funds left over for their college education.
- Go for a mix of investments between taxable and tax-free investments, and aim to concentrate the growth portion of your investments in your taxable accounts and the income-producing portion in your 529 or Coverdell ESA.
The Bottom Line
Saving now for your baby’s future college education will give you more freedom and more options later down the line. With a healthy college fund, your child won’t need to be dependent on financial aid, nor will they be forced to take out crippling student loans.
There are several different types of college savings accounts for your baby, including 529 plans, Coverdell ESAs, Roth IRAs, and traditional savings accounts. For most families, a 529 plan will be the right choice to maximize the most benefit for your child.
Frequently Asked Questions (FAQs)
What is the best college savings plan for my child?
There are various college savings plans, from education-specific programs like 529 savings plans and Coverdell ESAs to more general options like Roth IRAs and even savings accounts. Each type of plan has its own pros and cons, so in the end, it’s down to your family’s needs and preferences. If you’re in doubt, you can always diversify your portfolio and enjoy the benefits of each by opting for a mix of two or more different types of plans for your baby.
Should I start a 529 plan before my child is born?
You can start a 529 plan anytime, and the earlier, the better. The sooner you set up your account and start making contributions, the more time you’ll have for your investment to grow before your baby goes to college. Thanks to compound interest, contributions you make early on can grow exponentially by the time your little one is 18.
Therefore, if you’re in a position to open a 529 plan before your baby is born, this could help you maximize the benefits and minimize the amount you’ll eventually end up paying for your child’s college education. Technically, you’ll need a social security number for your baby to open a 529 plan for them, but there are a couple of workarounds for this. learn how here.
How much should I put into my child’s 529 plan per month?
The most important thing is to contribute as much as you can afford while trying to make as many payments as possible, mainly when your child is young. Most experts recommend contributing between $5000 and $30,000 per year to 529 plans, but the earlier you start, the lower end of this range you can aim for.
It’s also essential to keep contribution limits in mind so that you don’t incur tax penalties, though these are very generous for 529 plans. The key limit to watch out for is the gift tax exclusion, which for 2024 is $18,000 per person. You can use our free calculator to estimate what you should save.
How much will my baby’s college education cost?
As college tuition, fees, and education expenses are constantly rising, it isn’t easy to know precisely how much your baby will need to pay to attend college. However, based on current trends, many experts predict that in 18 years, a four-year degree will cost around $180,000 for public schools and $300,000 for private universities.
