Paying for College with Savings and Investments

Building a college fund? Explore some potential homes for it.

Mother with young daughter measuring her growth - now is the time to start saving for their college education.

Many students use a variety of funding sources—including scholarships, loans and savings—to pay for college. If you and your family can put aside money for college ahead of time, then grow it through investments and the power of compound interest, you may save a significant sum over time. Here are four popular options for college funds, plus some tips on how to use them.

Savings account

A savings account's a low-risk way to stockpile money for college expenses. You can open a savings account at almost any consumer bank or credit union, or at an online financial institution.

Nearly all traditional savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). This means that if your financial institution were to fail, you wouldn’t lose the money your financial institution has insured. Most banks and credit unions will insure up to $250,000 of the money in an individual savings account. If you open other types of accounts—a joint checking account, for instance—you may be eligible for additional coverage.

While savings accounts are very safe and can be used for nearly any kind of expense, your money won’t grow very fast in them. That’s because their interest rates are relatively low. Other savings products such as money market accounts and certificates of deposit (CDs) typically have higher interest rates , and they can be good options if you’re saving for the near future. A financial advisor can help you weigh your options.

529 plan

If you’re a parent, you can use 529 plans to save for the education of one or more children. You can invest this money in diversified stock and bond funds after it has been taxed, then watch it grow tax-free. If you use this money on qualified education expenses—including tuition, school fees, certain housing expenses and some types of school supplies—you won’t pay taxes when you withdraw it.

Grandparents can establish 529 accounts for their grandkids or contribute to 529 plans their grandkids’ parents have created. There are even gift cards that make this process easy. Just be sure everyone involved knows how 529 contributions might affect their taxes and the child’s financial aid eligibility. A financial advisor or tax expert can be a helpful resource.

You may enroll in a 529 plan based in any state, but Wisconsin’s plan, Edvest, offers additional benefits if you file taxes in Wisconsin. For example, you can deduct more than $3,000 per year for each child you’ve named as a beneficiary of an Edvest plan.

Plus, as of December 2019, you can use a portion of your 529 funds to repay student loans. This option stems from the SECURE Act, which states that up to $10,000 of a beneficiary’s student loans can be paid from a 529 plan without triggering taxes or penalties. This legislation applies to federal student loans and many private student loans.

Though 529 plans have many attractive features, they also have restrictions. For example, if you don’t use your 529 money for qualified educational expenses, it is subject to income tax and a 10% penalty. You also can’t change your investments more than twice a year.

Like most investments tied to the stock market, it’s possible to lose the money you’ve contributed. Keep this risk in mind as you build your college payment strategy.

Coverdell education savings account

A Coverdell account is another place to save money for college. You can also use the money for certain expenses associated with elementary, middle and high school.

Like a 529 plan, a Coverdell account is a way to grow your money tax-free. The money is taxed right before it enters the account. When you withdraw the money, it is not taxed if you use it on a qualified education expense.

Coverdell accounts have a broader range of qualified educational expenses than 529 plans do. For example, you won’t be taxed or penalized if you withdraw the money to pay for school uniforms or tutoring. These expenses would trigger a tax and a penalty if funded with 529 money.

Though a Coverdell is more flexible than a 529 in terms of how you can spend the money, it’s difficult to save a large sum of money in them. Right now you can save $2,000 per year for each child you name as a beneficiary of a Coverdell account. By contrast, a 529 plan can house thousands—or even hundreds of thousands—of dollars.

Plus, Coverdell money must be used by the time a child turns 30. Money in a 529 plan can be used for educational expenses at any time in a child’s life, and it can be shifted to the 529 accounts of other family members. For more information on both of these options, talk with a financial advisor.

Roth IRA

A Roth IRA's an individual retirement account that many people use to save money for their golden years. You can open a Roth IRA at many different banks, credit unions and online financial institutions. Though “retirement” appears in its name, a Roth IRA can be used for a few other kinds of expenses, including higher education.

As long as your Roth IRA account has been open for at least five years, you can withdraw money tax-free to pay for qualified education expenses, including a child’s college tuition and textbooks. If you withdraw money for other reasons before age 59 ½, it will usually be subject to a penalty.

Unless your money has been growing in a Roth IRA for quite some time, it probably won’t be enough to cover every expense associated with college. That’s because the maximum yearly contribution is relatively low: $6,000 in 2020 if you’re age 49 or younger, $7,000 if you’re age 50 or older. Plus, tread carefully if your child is planning to apply for financial aid. Once you withdraw Roth IRA funds, they can be counted in your child’s expected family contribution (EFC). This means that your student may have access to less money in the form of federal student loans and need-based scholarships.

One drawback of Roth IRAs is that they’re only available to people in certain income brackets. If you’re married and file taxes jointly, you can fully fund a Roth IRA if your modified adjusted gross incomes less than $196,000. If you are a single filer at tax time, your modified adjusted gross income must be less than $124,000.

Proceed with caution if you’ve been using a Roth IRA to save for retirement. Financial experts typically recommend getting your retirement savings on track before saving for a child’s education. If dipping into your Roth IRA might jeopardize your retirement, be sure you’re considering other options. For more specifics about Roth IRAs, and to determine if they’re a good fit for you, contact a financial advisor.

Finally, keep in mind that savings and investments aren’t the only way to finance higher education. Many people combine these funds with loans and scholarships to pay for a college degree. The most important steps are setting a goal, crafting a savings strategy and trying your best.

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