Saving for College: 3 Tools for Playing the Long Game

The high price of higher education may seem daunting, but there’s a science to saving for college that favors planners who patiently play the long game. 

Tuition at American colleges and universities may have slowed in 2020, but the reprieve is only a blip. Annual tuition hikes averaged about 5% between 2000 and 2020, and the average cost of college is 30 times more expensive than it was just 50 years ago. Those jaw-dropping stats are enough to make anyone start socking away some serious cash for college. 

The estimated annual cost of attending a four-year private institution was nearly $55,000, according to a 2020 report by the College Board. At four-year public colleges and universities, the annual cost for out-of-state students was more than $43,000, while in-state students could expect to pay about $27,000.  

That’s a sizable expense by any measure. Putting together a solid college savings plan can help alleviate anxiety and avoid—or greatly limit dependence on—student loans, which have reached crisis levels. About 7 in 10 of college students had loans in 2019, and graduates that year averaged almost $30,000 in loan debt. 

If college is in the cards for you or your children, here are some of the best college savings plans to help you get ahead of the curve. Find the right one and start putting money aside as soon as possible. Saving for college is a long-term strategy, so give yourself the best chance of succeeding by starting early and staying disciplined.

1. Set up a custodial account you can transfer to your child.

Custodial accounts are a versatile savings tool that go by many different names. Sometimes referred to as gift trusts, these accounts allow adults to accumulate money or assets for a child under 14 with certain tax advantages and no contribution limit.

There are two kinds of custodial accounts: UGMA and UTMA. UGMA stands for the Uniform Gift to Minors Act, and UTMA stands for Uniform Transfer to Minors Act. There are a few minor differences, but they essentially operate the same way. Established under the minor’s name, these accounts typically allow stock, bond and mutual fund investments in addition to cash. And UTMA accounts can actually hold real property and real estate.

A certain amount of investment income from these accounts is untaxed, while the rest is taxed at the child’s tax rate. However, at a certain point, the adult’s tax rate kicks in, which could be as high as 37%. That’s a biggie in the cons column, as is the fact that these assets count against financial aid. Students are expected to use 20% of their assets per year to pay for college. 

UGMA/UTMA assets are automatically transferred from the custodian to the account holder between the ages of 18 and 21, depending on the state. It’s important to note that custodians have no control over how the assets are used after the transfer—even if the savings were always intended for college.

Pro tip: Open a custodial account as a child college fund when your kid is young and have them actively contribute small amounts over time to teach the importance of saving. They’ll feel more invested—and they literally will be!

2. Lessen the tax impact with a 529 college savings plan. 

When it comes to saving for college, it’s hard to beat the benefits of a 529 plan. Named after the relevant section of the IRS tax code, these plans are considered by many financial advisors as the best way to save for college. 

Most college savings are in 529 plans, according to a recent report by Sallie Mae. About 30% of the money saved by survey respondents was invested in the plans, and the average amount saved had doubled from $2,820 in 2016 to $5,441 in 2018. That’s good news for parents looking to chip away at the rising cost of college. 

There are many reasons 529 plans come out on top when weighing your college savings options. First off, they’re available in every state, sponsored by state governments and you can invest in any state’s plan—some of which are more appealing than others. There’s no downside to having more choices. 

The tax advantages of 529 plans are also a big selling point. Similar to a Roth IRA, 529s allow you to invest after-tax money in stocks and bonds, and earnings aren’t federally taxed if used for qualified college expenses, such as tuition, room and board and books. And some states, including Missouri, offer a state income tax deduction for investing in their 529 plan.

There’s also a key difference between 529 plans and Roth IRAs: 529s offer much higher contribution limits. Given the steep cost of higher education, you want the ability to save as much as possible. Plus, you can change your designated beneficiary at any time, and 529 assets don’t count against financial aid—giving them a leg up on custodial accounts. Bottom line: The pros column for 529 plans is hard to ignore. 

3. Cover more educational expenses with a Coverdell Education Savings Account.

The Coverdell Education Savings Account, or ESA, is an alternative to 529 plans that gives you more flexibility at the expense of lower contribution limits. Formerly known as education IRAs, assets in these accounts can be used to pay for college, as well as qualified elementary and secondary educational expenses. 

For example, ESA savings can be used to pay tuition for primary and secondary schools in addition to uniforms, tutoring and other K-12 expenses without triggering a penalty. ESAs also offer expanded investment options over 529 plans, so a Coverdell might be the right choice for you if you’re a savvy investor.

Unfortunately, these accounts have some fairly significant limitations. Parents can only contribute $2,000 per beneficiary per year until the child turns 18. ESAs are all about the long game. If you invest the maximum amount each year after your child is born, the savings can really add up. At a conservative 7% annual yield, you could save more than $72,000 by the time your child turns 18.

But here’s the biggest catch: You must fall into a narrow income bracket to even participate in ESA plans. Only married couples earning between $190,000 and $220,000 or individuals earning between $95,000 and $110,000 are able to contribute to a Coverdell. Thankfully, you can always roll over your ESA to a 529 plan if you decide to shift your strategy. 

Are you interested in learning about other college saving options? If so, contact Community Point Bank to find a plan that best fits your unique situation. After all, saving for college is a big endeavor. Why not lean on your local bank for some helpful advice?