For most parents, supporting their children’s college fund will be one of the most daunting investments they’ll ever have to save for. It’s challenging to fund college by pooling money and interest into a traditional bank savings account, and this funding process isn’t getting any easier.
According to the latest 2019-2020 estimates calculated by Vanguard’s College Cost Projector, the average fees for a year of public college will balloon to a whopping $52,825 in 18 years, over double what it currently is ($21,950). Multiply those 52 G’s across four years, and that will add up to a whopping $227,684 average price tag, excluding transportation costs, room and board variables, and additional expenditures you may need to account for.
All these expenses bear in mind many questions, but namely, how exactly are you supposed to save up for it all? Whether you’re saving for your child or saving for your own continuing education as an independent, it’s going to be a tough, bumpy ride. Fortunately, there are plenty of college savings plans out there, and plenty of different ways they can mitigate your financial headache. Granted, some plans may be better suited at doing that than others; read on for a closer look at each type of college savings plan.
Prepaid Tuition Plan
One of the two types of state-run 529 college savings programs, a prepaid tuition plan is relatively self-explanatory; it allows you to prepay for credits at participating institutions, at their current price rates. Earnings placed into this fund are not taxed, and may actually qualify for tax breaks depending on the state and plan. Most prepaid tuition college savings plans are run through public institutions and have many rules based around in-state residency, but over 250 institutions participate in the Private College 529 Program.
There are many reasons someone may want to opt for a prepaid tuition plan: the aforementioned tax benefits, the simplicity of simply storing for later, and the ability to move ahead of the curve of inflation. However, these sorts of college savings plans aren’t without their flaws, as they may have mixed definitions of what counts as “qualified educational expenses,” and any expense that isn’t qualified can be subject to state or federal income tax.
Furthermore, some states and institutions may offer far less affordable monthly payment rates than others – what may be a relatively inexpensive prepaid tuition plan in one area may be exorbitantly pricey in another. Additionally, not every area’s prepaid 529 tuition plan has the safety net of guarantee. If the provider’s state government sponsor runs into financial turbulence or funding cuts, some (or all) of your funding’s earnings may be lost. Always read up on your local 529 plan’s rules and regulations before committing to anything.
Custodial Brokerage Account Plan
Run by an adult closely tied to the child’s life (parents, grandparents, other relatives, or family friends), this type of college savings plan establishes a fiduciary relationship between the “custodian” adult and child until they are no longer a minor, at which point the funding transfers to them. The main ways a custodial brokerage plan may be advantageous over a 529 plan are the looser restrictions and broader flexibility. There are no funding contribution limits, and brokerage account plans allow for a wider range of investments through the broker.
Granted, Uniform Gift To Minors Act (UGMA) brokerage plans may only be permissible for use in a limited set of gifts (though still more beyond education), but custodians who invest under a Uniform Transfer To Minors Act Plan (UTMA) can invest in any asset, so long as it’s for the benefit of the minor. Earnings in both forms of brokerage accounts are subject to taxation, but given that the minor’s assets are weighed more than the custodians, these deductions are generally small and negligible.
From a versatility standpoint, custodial brokerage accounts can be advantageous over 529 plans. However, fewer limits are not synonymous with zero limits. There are a few key downsides to custodial brokerage accounts. First and foremost, any money invested cannot be transferred to another beneficiary should anything go awry.
Furthermore, weighing the minor student’s assets so greatly can be a double-edged sword. While taxes are reduced, the FAFSA’s expected family contribution (EFC) figure is typically increased, limiting potential financial aid. Finally, after the assets are transferred to the child upon adulthood, no rules guarantee that they’ll use those assets for educational purposes.
Consider these issues carefully, and read up on any brokerage account provider before you agree to anything.
Education Savings Plan
The other variant of a 529 college savings plan, an education savings plan allows the saver to open a funding account for their beneficiary. A bit of a medium between a 529 prepaid tuition plan and custodial brokerage account plan, the account owner has versatile control over investing in assets beyond college credit, but expressly to support the beneficiary’s education.
Like the other form of 529 plan available, invested earnings are not generally not subject to taxation, provided they’re put toward qualified educational expenses.
Unlike 529 prepaid tuition plans, though, you and/or your child(ren) do not have to be residents of the state offering them to qualify for most education savings plans. And unlike custodial brokerage accounts, asset ownership is not transferred when the beneficiary reaches adulthood.
An education savings plan may be an advantageous option if you’re worried about improper funding allocations or negative financial aid ramifications. However, education savings plans can be subject to many of the same potential disadvantages that prepaid tuition plans can have, including inordinately expensive payment rates, contribution limits, usage limits, limit to only two asset reallocations a year, and other potentially limiting constraints.
Before you commit to any one particular 529 payment plan, evaluate it through the College Savings Plan Network, and assess their cost estimates with the Financial Industry Regulatory Authority’s 529 Calculator Tool.
Coverdell ESA Plan
A Coverdell Education Savings Account (ESA) is very akin to a custodial brokerage account and 529 education savings plan, where the account owner is tasked with making investments for educational expenses on the child’s behalf. Unlike 529 education savings plans, however, Coverdell accounts can be used to build up more tax-free contributions to the child’s K-12 education than just tuition. This may be the best option if you want to be particularly careful about saving over your children’s education, not just their higher education.
That said, a Coverdell ESA, like every college savings plan on this list, has its drawbacks. For one, the contribution limit is a meager $2,000. While that should be sufficient for K-12 expenses, it’s a bit mediocre in the realm of saving for college. Moreover, while 529’s and custodial accounts have no age limit to pay off, a Coverdell ESA must be paid off by the time the beneficiary turns 30 years old.
Ultimately, there is no universal “best” college savings plan available. The “best” depends on personal factors like priorities, financial needs, and overall preference. We highly recommend that you consult a professional financial advisor to extrapolate a clearer picture of what exactly that personal “best” means to you.