What's the Right College Savings Plan for My Child?
- Oct 12, 2018
- 4 min read
Updated: Mar 18
Follow this 5-step plan to get your college savings fund in order
With the national student loan debt resting at $1.71 trillion*—and rising—saving for college is a big deal. And, while most of us don't have $40K to front all at once come college, saving over time can be incredibly helpful for you and your child. In fact, a college savings plan can help your child avoid having to take federal loans and be saddled with debt for five, ten, or even 30 years.
You might have a newborn baby or be recently pregnant. This still applies to you! Setting up your college savings plan is an important part of your new baby financial plan updates (See: A Baby Changes Everything). Or, you may be in the middle of determining if you should get your child a 529 college savings plan (See: Does My Child Need a 529 College Savings Plan?).
Stick around, and we'll help you cover the main questions about college savings plans:
What are the college savings plan options?
What type of college savings plan is right for my child and me?
How do we invest in a college savings plan?
How much should we invest in a college savings plan?
What are the college savings plan options?
When saving for your child's college tuition, you have several options to consider. Just like we recommend you do for all financial decisions, both big and small, weigh the benefits before you make your selection. And, if you have a partner or spouse who is contributing, we recommend getting them on board, too.
College savings plan options include:
State 529 college savings plans—direct-sold — can be lower-cost, DIY options you can open online.
State 529 college savings plans—broker-sold are accounts that you can open through your licensed financial advisor. A 2018 Fidelity report** found that 67 percent of people who worked with a financial advisor felt they had a good understanding of how to save for college, as compared to 40 percent of those who did not work with a financial advisor.
Prepaid 529 college tuition plans are tax-advantaged college savings programs, where you purchase tuition at current rates. Similar to a rent-controlled apartment, these plans allow you to purchase tuition credits at the current cost, rather than the likely inflated cost when your child is in college.
Educational savings accounts (ESAs) are savings plans that help you save and pay for education expenses from kindergarten through college. Account earnings can grow tax-deferred, and withdrawals are tax-free when used for eligible expenses.
Custodial accounts are savings accounts with financial institutions that an adult controls for a minor. These accounts don't have withdrawal penalties or require distributions, but, unlike 529 college savings plans and educational savings accounts, custodial accounts are not tax-exempt.
Savings bonds are generally thought of as loans to the federal government. That's right; you lend money to the federal government for a certain period of time and, when that time is up, the government pays you back in full—with interest.
How to choose between college savings plan options
Lately, it seems that the state-sponsored 529 college savings plans are highly popular. Many financial professionals prefer these because they offer the greatest flexibility.
The main benefits of 529 college savings plans are:
You can sock away the most amount of money each year
You may be eligible for a state tax deduction
If you elect the proper plan and investment option, these plans are relatively "self-managing"—you can set it and almost forget it (we say almost because we're big fans of keeping an eye on your investments)
Selecting the right 529 plan
Most states offer at least one 529 plan option, so how do you know which is the right plan? You shouldn't necessarily elect the 529 plan of your state of residence. It may sound strange or counterintuitive, but some states' plans are better than others in terms of performance, management, and fees. Not to mention, the sole benefit of using your own state's plan is typically the tax benefit. But, that benefit may or may not be major (or even relevant) in your state, if your state has a no state income rate or doesn't offer a tax deduction for 529 plans.
Your Checklist for picking the right plan
Follow the checklist below and evaluate the following items to determine which college savings plan is right for you and your family:
Do you want to try the broker route? As previously mentioned, there are broker-sold plans, which pay a commission back to the broker who sells it to you. These plans tend to be more active than passive—meaning your broker is constantly working on getting you the best savings and, therefore, justifies their broker fees.
Do you want to try the direct route? As opposed to the broker route, where you purchase a 529 college savings plan from a broker, going the direct route means you log on to the state 529 website and fill out the forms yourself. This method is passive, as you set the account and almost forget it. If you elect the right one, you will not need to pay a broker fee.
State Tax Rate: Does your state have an income tax?
State Tax 529 Eligible Deduction: Does your state offer a tax deduction for your contributions to 529s?
Strength of Plan: Some plans are better than others. We trust Morningstar and the annual rankings they do of state 529 plans.
There you have it! Finding the right college savings plan for you and your family can be as simple as evaluating five short steps! Before you start diving into your college savings plan, make sure you've paid down big debt (See: How to Pay Off Debt When Cash is Tight) and are already saving for retirement (See: No 401k? We Can Work with That and How Much Should I Save for Retirement?). After all, it's important to make sure you're financially stable before investing in your child's college savings plan.
*Student Loan Hero, 2021
**Fidelity, "College is No Free Ride: One-in-Three Families Expect Kids to Save Over $10K for College Costs by High School Graduation (But Haven't Told Them Yet)", 2018
