How Do I Save for My Child's College?
There are two basic types of accounts that are designed for saving for college, both of which are tax-advantaged savings vehicles. The first of these is the ESA, or the Education Savings Account. You can open this type of account with most investment companies, but the limitation is you are only able to contribute $2,000 per year to this account. However, a benefit of an ESA is that you are also able to use this money for secondary education, like paying for your child to attend a private high school, in addition to paying for qualified college expenses. The money in this account grows tax-deferred and as long as you withdraw it for qualified expenses, it comes out tax-free as well.
The other type of college savings account that you can use is a state sponsored 529 plan. Every state has at least one of these plans available, and inside each of them is an array of investment options that are pre-allocated portfolios diversified between asset classes. We recommend choosing one of the age-based investment options that invests more conservatively as your child approaches the start of college.
The great thing about a 529 plan is that you can put a lot more money into it than an ESA – probably much more than you would want to invest in the plan. With a 529 plan, not only can you fully fund college for your child for most institutions, but you may also get a state tax deduction for your contributions to the plan and can then withdraw the money tax-free for qualified expenses. So, while an ESA is certainly an improvement over keeping cash in the bank, we recommend most people look to a 529 plan as the likely best option for investing for college.
Steve Marbert is a CFP® and the President of Richard Young Associates, and is a Dave Ramsey SmartVestor Pro. Want to learn more about him and our other advisors? Find out more here.