College Savings Plans: Smart Ways to Fund Higher Education

College costs are rising faster than inflation. Data shows that average tuition and fees at private colleges climbed by about 5.5%.

The typical expense for higher education in the United States amounts to $38,270. At a public 4-year institution, a student residing on campus allocates $27,146 for a single academic year.

A private, nonprofit university student invests $58,628 annually for on-campus living, with $38,421 allocated to academic expenses (tuition and fees).

How can families prepare for this major expense? Starting a college savings plan early can make a huge difference.

529 Plans: The College Savings Powerhouse

529 plans are state-sponsored investment accounts specifically funded for education expenses.

“529 plans offer significant tax advantages that many families overlook. These plans allow your investments to grow tax-free when used for qualified education expenses, potentially saving thousands compared to traditional savings accounts,” notes David Beckerman, Senior Vice President, Investments.

These plans offer significant tax benefits:

• Earnings grow tax-free
• Withdrawals are tax-free when used for qualified education expenses
• Many states offer tax credits and/or deductions for contributions

There are two main types of 529 plans:

1. College Savings Plans:

• Similar to retirement accounts
• Offer various investment options
• Can be used at most U.S. colleges and many foreign schools
• Can also be used for K-12 tuition (up to $10,000 annually)

2. Prepaid Tuition Plans:

• Lock in today’s tuition rates at in-state public colleges
• Provides protection against tuition inflation
• Offered in some states but not all

The best part about 529 plans? Anyone can contribute—parents, grandparents, other relatives, or friends. There are no income limits to participate.

You can open a 529 in any state, not just your home state. However, your state might offer tax benefits for using its plan.

Many 529 plans have age-based investment strategies that automatically become more conservative as your child approaches college age.

Coverdell Education Savings Accounts (ESAs)

Coverdell ESAs are another tax-advantaged option for college savings.

Key features include:

• Tax-free growth and withdrawals for qualified expenses
• Can be used for K-12 expenses as well as college
• More investment options than most 529 plans

However, Coverdell accounts have limitations:

• Annual contribution limit of only $2,000 per beneficiary
• Income limits for contributors
• Contributions must stop when the beneficiary turns 18
• Funds must be used by age 30

For most families, a 529 plan offers more benefits than a Coverdell ESA.

UTMA/UGMA Accounts for College

Uniform Transfers/Gifts to Minors Act (UTMA/UGMA) accounts are custodial accounts that can be used for college.

These accounts offer:

• No contribution limits
• No restrictions on use of funds
• More investment options

The downsides:

• No tax advantages for education specifically
• Child gains control of the money at age 18-21 (varies by state)
• Can significantly impact financial aid eligibility

These accounts make more sense for general savings for a child rather than specifically for education.

When to Start Saving for College

The best time to start a college fund is when your child or grandchild is born. The power of compound growth works the same way for college savings as it does for retirement.

Even if you can’t save the full amount needed, every dollar you save is one less dollar of potential student loan debt.

How Much to Save Based on Public vs. Private Education

College costs vary widely depending on the type of institution.

Many financial advisors suggest aiming to save about one-third to one-half of expected college costs. The rest can come from current income, financial aid, and student loans if necessary.

Balancing College Savings with Retirement Planning

An important rule: don’t sacrifice your retirement for your child’s college fund.

Why? Because:

• You can borrow for college, but not for retirement
• Children have decades to pay off reasonable student loans
• Financial aid is available for college, but not for retirement

If you must choose between funding your 401(k) and a college fund, prioritize the 401(k)—especially if your employer offers a match.

A good sequence:

1. Contribute enough to your 401(k) to get the full employer match if offered
2. Build an emergency fund
3. Pay off high-interest debt
4. Then, start or increase college savings

Maximizing Financial Aid Opportunities

How you save can impact financial aid eligibility. Assets in a child’s name (like UTMA/UGMA accounts) reduce aid eligibility more than parent-owned assets.

For maximum aid eligibility:

• Keep savings in parent-owned accounts when possible
• Consider 529 plans owned by grandparents or other relatives
• Be strategic about timing of 529 withdrawals from non-parent accounts

The Free Application for Federal Student Aid (FAFSA) was simplified in 2024 but understanding how your savings affect aid remains important.

Start Today, No Matter the Amount

The most important step is to begin saving, even if it’s just a small amount monthly.

Consider making automatic payments by setting up regular transfers to your college savings account.

Consider asking family members to contribute to the college fund instead of giving toys or other gifts for birthdays and holidays.

Remember that every dollar saved is potentially two dollars not borrowed when you factor in interest costs and inflation.

Your child’s education is one of the most important investments you’ll make. With early planning and consistent saving, you can make it a reality without sacrificing your own financial security.

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Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.