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Your Kids: Starting a College Savings Account

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Jul 17, 2012 Eve Hullett, Columnist | 0 Comments

With college costs continuing to skyrocket, parents, grandparents, and other caregivers must find ways to save money well before a child graduates high school. Saving early is especially important if multiple children will be attending college. estimates that a private college education will cost as much as $340,800 by 2028. Attending a public university as an in-state resident may cost as much as $95,000 by 2028. Even those who attend community college for two years and private college for two years should expect to spend $196,300. Fortunately, there are several ways to save, making it possible to reduce the amount of loan money needed to attend college.

Benefits of Saving Early

Saving money early has several advantages. Those who invest money in bonds and other types of investments have plenty of time to let their accounts grow and accumulate interest. Putting money in interest-bearing accounts even increases the amount of money saved. When interest is added to the principal amount, and that interest begins to earn interest, this is known as compound interest. Compound interest can help a savings account grow significantly until a child is ready to go to college. Saving early also makes it possible to weather financial emergencies. If it is not possible to save a lot of money one year due to job loss or a salary decrease, parents have the option to save less that year and make up for it in another year.

Saving vs. Borrowing

When saving money for college is compared with taking out college loans, saving money is clearly the better choice. Those who save money can use interest to their advantage and grow their accounts over time. When a student or parent borrows money to pay for college, the lender charges interest that can significantly increase the total amount borrowed. Borrowers are then forced to pay back their loans over a long period of time. If someone who borrowed money is unable to get a job that pays well, paying these loans can represent a significant financial burden after college. This makes it much less expensive to save early than to borrow money when a child is ready to attend college.

Saving Options

Those who want to start saving early have several options for maximizing their savings. One of the most basic options is a savings account started before a child is even born. Some employers allow their employees to deduct a certain amount of each paycheck and have it deposited directly into the savings account. This makes it easy to save and eliminates the hassle of having to make deposits at the bank. However, savings account rates are currently much lower than they were in the past, so the return is not as great as the return on other types of accounts. Investing in stocks, municipal funds, and other types of investments is another way to save for college. This type of investing is more complicated than simply putting money in a savings account, but the returns are often higher. An experienced financial advisor can recommend investments that match the financial goals of each borrower. There is the potential to lose money on these investments, so this is a riskier type of saving than using a savings account.

Some people buy savings bonds as gifts instead of giving children money or toys. This is a practical gift that can pay off when it comes time to go to college. Bonds accumulate interest over time, so the amount of the initial investment grows. EE savings bonds pay interest based on the current market rates. I savings bonds protect investors against inflation by paying specific interest rates that depend on when the bonds are bought and redeemed. These bonds are issued by the U.S. government, so they are considered low-risk. Bonds bought after 1989 and turned in by someone who is at least 24 years of age may be redeemed tax free if the money is used to pay college tuition and fees. An annuity is another option for college savings. Under an annuity contract, a person pays a life insurance company a lump sum that will be distributed back to the person over time.

Tax-advantaged plans such as the 529 plan encourage people to save for future college expenses. The savings plan typically consists of mutual funds. They grow based on the market performance of these funds and other investments. Most state plans offer the option to take more risk when a child is young and move to more conservative investments as the child gets closer to attending college. Some states also have prepaid savings plans, which are administered by the states themselves or by individual colleges. These plans allow people to purchase tuition credits at current tuition rates. Distributions from qualified plans are exempt from federal income taxes, making them a favored savings option.

A Coverdell Education Savings Account is another tax-advantaged education savings plan. The Coverdell plan covers tuition, uniforms, books, and other necessary education supplies. The money withdrawn from one of these plans is exempt from federal taxes. The difference between this type of plan and the 529 plan is the fact that a Coverdell plan also covers elementary and secondary expenses in addition to college expenses. The money from these plans may be used for tuition, uniforms, books, and necessary education supplies. Another important difference is that 529 plans have no age limit, however the money in a Coverdell ESA has to be used before the beneficiary is 30. If the funds have not been used, they must be given to a relative under the age limit to avoid penalties and taxes.

Tax Breaks

The government encourages people to pursue higher education by offering tax credits and tax breaks for those who attend college. The American Opportunity Tax Credit allows people to claim a certain amount of tuition and fees on their taxes. Parents may claim this credit if their children are listed as dependents. Children may claim the credit only if they are not listed as dependents on any other tax return. The amount of money a person earns affects how much he or she can claim under this credit. The credit is limited to four tax years for any one student. Another available education credit is the Lifetime Learning Credit. This credit allows a taxpayer to claim a credit of 20 percent of up to $10,000 in fees and tuition. This credit differs from the American Opportunity Tax Credit because there is no limit to how many years the credit can be claimed. Someone who claims the Lifetime Learning Credit may not claim the American Opportunity Tax Credit in the same tax year. In some cases, students may also be able to deduct the amount of interest paid on student loans.

Scholarships and Grants

In addition to saving faithfully, scholarships and grants can also help students avoid having to take out college loans. Scholarships are typically awarded based on stated application criteria. Some scholarships are based only on academic performance. Others are awarded based on participation in athletics, music programs, or other extracurricular activities. Students may have to meet certain minimum requirements to keep their scholarships for the duration of their education. Grants are available through federal agencies, state agencies, and private organizations. One of the most well-known programs is the federal Pell grant. This grant is given to low-income students who are enrolled at least part-time. This grant does not have to be repaid, making it an attractive alternative to loans.

With all of the savings options available, saving for college early is much better than taking out loans to cover college costs. Consumers have the option to invest in savings bonds, annuities, savings accounts, mutual funds, and tax-advantaged college savings plans. Several tax credits are also available to those who are enrolled in qualified education programs. Enrolling in a college savings plan may even have tax benefits that college loans do not offer. Start saving early and reduce the stress associated with paying for college.

The following resources explain the available college saving options in detail. Use them to determine the best way to save money based on individual circumstances.

  • An Introduction to 529 Plans: This resource from the U.S. Securities and Exchange Commission explains what a 529 plan is and how the two types of plans differ.
  • EE/E bonds: This guide from TreasuryDirect explains how series EE bonds work.
  • Compare 529 Plans and Coverdell: This guide allows readers to compare 529 plans with Coverdell plans and pick the best one for their needs.
  • College Savings Plans Comparison Chart: The Motley Fool takes a look at the different college savings plans available and explains how each one affects financial aid eligibility.
  • Coverdell Education Savings Account: This guide from the IRS explains the tax implications of Coverdell ESAs.
  • Savings Account: Investopedia explains what a savings account is and some of the limitations on this type of account.
  • College Savings Calculator: This calculator allows parents and students to enter their expected annual costs, current savings, and number of years until college enrollment to determine how much they must invest each year to cover their anticipated expenses.
  • College Board Savings Calculator: This calculator allows students and parents to determine if they are saving enough money for college.
  • Saving for College: Baby Center encourages parents to start saving early for their children’s college educations. This resource explains that college costs continue to rise, making it important to save early.
  • Pell Grant: This resource explains the Pell grant program in detail and discusses the eligibility requirements.
  • Scholarships: FinAid explains what scholarships are and lists some of the best resources for finding them.
  • Borrow Responsibly: This resource explains the true cost of taking out college loans.
  • College Savings Tips: This article from CNN offers five tips for saving for college.
  • Tips for Saving: This guide shows exactly how saving for college stacks up against borrowing for college.
  • Are You Saving for Your Kids’ College?: This credit union resource discusses the importance of saving for college and explains how to choose a savings plan.
  • College Savings Guide: This financial planning resource links to a number of articles on saving for college and getting financial aid.
  • CollegeInvest Tips and Tools: This guide explains how to set savings goals and achieve them.
  • The Importance of Saving Early: This resource explains why it is so important to start saving for college as early as possible.
  • Why Save for College: This guide explains the four most important reasons to start saving for college early.
  • The ABCs of Saving for College: This resource discusses the importance of saving and offers tips for creating a savings plan.
  • Saving for College Portal: This portal contains the most recent news related to saving for college.
  • TAMU Saving for College Guide: This article contains an infographic that shows just how much money can grow over time.
  • This site allows students to create their own profiles and find information on scholarships.
  • FastWeb Scholarships: This site allows students to search a large database of scholarship opportunities based on their desired criteria.
  • How to Find Scholarships: This guide explains how to use scholarship search engines to find the best scholarships.
  • Family Ideas for College Savings: This article offers three ideas for saving for college when a child is young.
  • Tipsheet: Saving for College: This article is a comprehensive guide to investing in 529 savings plans.
  • Planning to Meet College Costs: This resource offers information about the tax credits available for college expenses.
  • The Lifetime Learning Credit: This article explains the criteria for claiming the Lifetime Learning Credit.
  • American Opportunity Tax Credit: This resource explains the differences between the AOTC and the Lifetime Learning Credit.




Eve Hullett


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