From the last day of 1982 through the last day of 2024, college tuition costs have outpaced any other household expense—growing a whopping 899%, or 5.6% per year, according to JPMorgan Chase.
If you’ve recently attended (or paid for) college, that likely doesn’t come as much of a surprise.
But that, plus the record levels of outstanding student loan debt, should impress upon new parents (and grandparents) the need to start saving for their child’s college expenses as soon as possible.
By setting aside money early and often, new parents can leverage the power of compound growth to offset ongoing tuition price inflation and the sticker shock that could come with a college acceptance letter.
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There are any number of ways to pay for college, from grants, loans and scholarships to gifts and saving, but let’s break down two popular savings methods that are accessible to all investors.
2 Ways to Save for Your Child’s College Education Now
Invest in Your Child’s Future with a 529 College Savings Plan
529 Savings Plans were created by Congress in 1996. A 529 education savings plan is an investment account that can be used by the account beneficiary of any age for qualified elementary, secondary and higher education expenses.
There are plenty of benefits to a 529 plan:
Anyone can contribute. One of the nice things about a 529 plan is that anyone—relatives, friends, etc.—can contribute to it. But since contributions are treated as gifts, you need to make sure that you stay within the annual gifting limit (which for 2025 is $19,000 for single filers and $38,000 for married filing jointly). However, another interesting provision about 529s is that they have a “super funding provision that allows you to contribute up to five times the annual gifting amount.”
Contributions may be tax-deductible in your state. Your contributions are not deductible for federal income taxes, but many state plans offer state income tax deductions for contributions.
Earnings grow tax-free.
Plans are considered the account owner’s assets for financial aid, not the students. Parental assets have less impact on financial aid than student assets or parental income.
Unused 529 plan assets may be allowed to roll into a Roth IRA for the beneficiary. Here’s information on the dos and don’ts. But note that if you use the funds for unqualified expenses, you’ll be assessed a 10% penalty plus taxes on earnings.
As for investments in the plan, your particular plan will offer several portfolios of mutual funds. At this time, you cannot choose individual investments, mutual funds, or ETFs in a 529 plan.
Each state offers its own 529 plan, but you do not have to use your home state’s plan. Just make sure you understand all the rules and regulations before investing.
Here’s a link to find a state plan.
Note that nine states currently offer prepaid 529 plans (down from 22). Here’s a link to find out more about them.
Another Option: Coverdell Education Savings Account
Coverdell accounts may be established for a beneficiary younger than 18 (or for a beneficiary with special needs).
Annual contributions are capped at $2,000 for joint filers with a modified adjusted gross income (MAGI) up to $190,000 and are gradually reduced for MAGI between $190,000 and $220,000. Incomes above $220,000 are ineligible.
Like 529 plans, earnings grow tax-free, and for financial aid purposes, Coverdell accounts are generally considered the account owner’s assets (e.g., parental assets).
If you still have funds in your Coverdell account when the beneficiary reaches 30 years of age (unless disabled), the balance must be distributed to a 529 plan for the same beneficiary or transferred to a 529 or Coverdell for another eligible family member. You cannot convert the balance to a 529 plan.
And like 529s, if distributions are used for nonqualified expenses, earnings are subject to taxes and a 10% penalty.
You can open a Coverdell account at major financial institutions, such as banks and online brokers, where you can deposit the funds into savings accounts and CDs. Both types of accounts tend to be very conservative, but also won’t offer high returns.
A Coverdell account may also be created at your brokerage company, and you can invest it in stocks, bonds, mutual funds, and ETFs, which have the potential to earn more than bank products.
This post has been partially excerpted from the latest issue of Cabot Money Club Magazine, to learn more about tackling higher education expenses, subscribe today to read the full article.
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