#5Save for a child’s education.

If you have children in the family, one of your goals is probably to set aside funds for their education. While Schwab recommends saving for retirement before saving for college, your personal priorities should be your guide. But remember—while your child may be able to get a loan for college, you can’t get one for retirement.

Two tax-advantaged ways to save

  • 529 college savings plans.1 Money can be withdrawn tax-free to pay for qualified college expenses like tuition, books, supplies, and, in some cases, room and board.
  • Education savings accounts. These accounts may be used for qualified elementary, secondary, and college education expenses. You can put away $2,000 each year per child (if eligible); potential earnings grow tax-free, and distributions for qualified expenses are free of federal income taxes. Income limits apply.
Projected cost of college in 15 years: $253,300Start saving now and pay less later. If you don't save now, you will pay $63,325 a year for 4 years for a total of $253,300. With a taxable account, you can save $8,480 a year for 15 years for a total of $127,200, and your investment earnings make up the rest. With a 529 college savings plan, you can save $7,120 a year for 15 years for a total of $106,800, and your investment earnings make up the rest.
Projected cost of college in 15 years: $253,300Start saving now and pay less later. If you don't save now, you will pay $63,325 a year for 4 years for a total of $253,300. With a taxable account, you can save $8,480 a year for 15 years for a total of $127,200, and your investment earnings make up the rest. With a 529 college savings plan, you can save $7,120 a year for 15 years for a total of $106,800, and your investment earnings make up the rest.

This chart shows out-of-pocket college costs for three different scenarios:

  1. Don’t save—just pay for college when it’s time. The nominal cost of four years of college in 15 years will be $253,300, based on a current one-year cost of $24,196 with 6% annual inflation.
  2. Save and invest in a taxable account.
  3. Save and invest in a 529 plan.

Make it happen.

Have questions?

What’s the best college account for me?

Use this chart to help you understand some of the key differences between your account choices.

529 college savings plan Education savings account (Coverdell) Custodial account
Primary goal Save for college Supplement education expenses Teach a child about investing
Tax advantages Tax-free growth, tax-free withdrawals3 Tax-free growth, tax-free withdrawals3 Growth taxed at special rates4
Contribution limit $365,000 lifetime limit per beneficiary5 Annual limit of $2,000 (income limits apply)6 No limit
Gift limit without incurring gift tax $70,000 ($140,000 per couple) in a single year7 $2,0008 $14,000 ($28,000 per couple)
Ownership Adult, or child if custodial 529 Adult Child at age 18 or 219
Financial aid impact Minimal10 Minimal8 Potentially significant11
Age limits None Contributions can be made until beneficiary reaches age 18. All funds must be distributed to beneficiary by the time beneficiary reaches age 30. Beneficiary must be under age 18 when account is opened.
Ability to change beneficiary Anytime Until beneficiary reaches age 30 Never

What kinds of college financing options are available?

There are four sources you can draw from to pay for college:

  • Existing income and assets from the parent and student
  • College savings accounts, such as 529 or custodial accounts
  • Financial aid, such as scholarships or federal student aid
  • Loans or lines of credit

Combining some or all of these sources can help you keep on track with your other investment goals— retirement, for example—and can provide tax benefits.

In what order should I fund and draw down multiple college savings plans?

Schwab recommends funding the Coverdell first—up to the maximum you’re eligible to contribute. Then if you can save more, fund the 529 to the extent you’re able (you can contribute to both in the same year). With a Coverdell, you’ll generally have more flexibility with respect to investment choices, and you can withdraw the money tax-free for qualified K–12 expenses as well as college. Otherwise, the two accounts are very similar. For more, see Get Smart About Saving for College.

Custodial accounts or trusts: What’s best for grandkids’ college education?

A custodial account can take the place of a trust in most cases, with a lot less hassle and cost. A custodial account generally has the same gift tax advantage as a trust—the ability to utilize the current annual gift tax exclusion because the gift represents a “present interest” even though the beneficiary has no control over how the money gets spent. In some cases, a trust may be preferable, despite the additional cost and paperwork, especially if there are special needs or the trustee wants to place restrictions on the use of the money beyond the age of 18 or 21. Keep in mind, however, that neither a custodial account nor a trust will offer any special income tax advantages. If your goal is to keep some control over the money while saving for education expenses in the most tax-efficient way possible, then consider a Coverdell Education Savings Account and/or a 529 college savings plan. In any event, you should consult on trust matters with a professional estate planner who’s an attorney or a CPA. For more, see Get Smart About Saving for College.

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