Funding Your Child’s College Education: Maximize Your Savings by Planning Ahead

Saving for a child’s college education is one of the biggest financial endeavors parents face today. Similar to building up a nest egg for retirement or purchasing a home, saving for college is a marathon, not a sprint. Tuition (and related expenses) continue to increase year over year with no end in sight, which means implementing a savings plan is more important than ever.

Knowing how much you need to save, when to start, and what savings and investment vehicles to use requires some planning. Fortunately, there are tools and resources available to help you reach your college savings goals.

It’s tough to predict the exact cost of sending your child to college in 15-20 years, but you can get a good idea, based on the last twenty years of data. In 2024, the average cost of one year of college expenses was $38,270. This figure includes tuition, fees, books, supplies, and room and board for one year of higher education.

College expenses overall have more than doubled in the 21st century, with a compound annual growth rate of 4.11%, outpacing average annual inflation rates.

While $38,270 per year was the average cost in 2024 for all college students (ranging from public in-state institutions to private out-of-state institutions), in-state school expenses averaged $27,146, a more affordable option to consider if saving is a concern.

Costs can be further reduced by choosing more affordable living expenses during college. If a student were to continue living at home or is able to secure affordable housing options, expenses can be lessened substantially.

While these estimations may be overwhelming, it’s important that you start formulating a plan for college funding as soon as possible. As with any long-term savings, starting early is your best bet for success.

You don’t necessarily need to have the total funds for a college education on hand ahead of time. Two popular savings options that many parents use when saving for college are the $2k Rule and the One-Third Rule.

The $2k Rule simply states that parents should save $2,000 per year of their child’s life for their college education. The One-Third Rule, on the other hand, assumes that parents will plan on paying for one-third of their child’s education expenses with savings, one-third with current income during their enrollment, and one-third with future income (e.g. student loans). Meeting the savings portion of the One-Third goal at the time of college enrollment, and continuing to contribute to expenses through the course of your child’s college career, may help to set your child up for success. Securing student loans equivalent to no more than one-third of the total cost can be a manageable way to pay off student loan debt without experiencing financial hardship. Of course, this strategy does require that you estimate the cost of your child’s future education.

The sooner you can start saving for college, the better. Some parents open a college savings account as soon as their child is born, and some even sooner than that. The longer you can build up your college fund, the more time there is for your money to compound and grow.

If you start saving early and regularly through a college savings plan, you can often accumulate the first third of your child’s college expenses by high school graduation. For an in-state public school, a good savings goal to target is $250 per month, starting from the time your child is born. For an out-of-state private institution, you will want to set aside at least twice as more per month.

There are several options to save money for college expenses, including 529 plans, UGMA or UTMA custodial accounts, and Coverdell Education Savings Accounts. Choosing the right account (or combination of accounts) will position your family to be able to afford the costs associated with higher education, without taking on unmanageable amounts of debt.

With any plan, consistent funding is key. If automatic payments are an option with the savings/investment plan that you choose, it is in your best interest to use that feature. Set up recurring payments from your checking account to the college savings account to make sure your child’s college fund continues to grow. If the recommended minimum $250 monthly contributions are outside your means, contributing what you can now, and increasing the amount over time as your earnings allow, can lead to the desired amount of savings.

Just as important as figuring out how much you need to save is choosing the right plan for your needs. During the selection process, two important items for considerations are: tax implications and financial aid implications.

529 College Savings Plan

529 plans are a great option for many reasons. Similar to an IRA, 529 plans are tax-advantaged investment accounts that allow you to hold a combination of investment securities such as ETFs, mutual funds, and target-date funds.

One main advantage of a 529 plan is that you can grow and withdraw funds for qualified education expenses tax-free with a 529 plan. Qualified expenses include tuition, fees, books, equipment, and housing during college or up to $10,000 per year for elementary and secondary education expenses. Also, contributions made to a 529 plan cannot be deducted from your federal income tax; however, some states allow deductions from your state income tax.

There are no income restrictions or annual contribution limits associated with 529 savings plans. However, any funds withdrawn for use outside of qualified education expenses will be subject to income tax and may incur a 10% federal tax penalty.

For parents with more than one child, a 529 plan offers some flexibility with the usage of funds. Any money that the original beneficiary doesn’t use for college expenses can then be used by a new beneficiary (for qualified expenses), so any leftover savings in your eldest child’s account can be used by the next child in line, assuming they are college-bound.

In most cases, a 529 plan will not impact your child’s eligibility for financial aid because the account is considered the asset of the parent, not the child. For any financial aid payout, your child’s total award cannot be reduced by more than 5.64% of the total asset. It’s likely that the tax-free growth of the account will outweigh any diminished financial aid.

UGMA & UTMA Custodial Accounts

UGMA and UTMA custodial accounts are savings and investment accounts controlled by a parent on behalf of their child until they reach the age of majority. Once your child reaches adulthood, the funds in these custodial accounts become available to him or her for use in any way they choose. However, with no restrictions on how the money in a custodial account is spent once your child reaches adulthood, this could act as a supplement to a 529 plan. Note that your child could use the funds for purposes other than education, so keep that in mind if you are selecting this type of account.

A significant benefit of UGMA and UTMA custodial accounts is the ability to take advantage of the gift tax exclusion. A parent can make an annual contribution of $15,000 as a tax-free gift without it impacting the lifetime gift and estate tax exemption, thereby allowing your savings to grow even more quickly. However, any earnings generated from those contributions in a custodial account are subject to income tax when your child starts making withdrawals.

Unlike a 529 plan, which results in minimal impact on financial aid eligibility, custodial accounts can significantly reduce your child’s financial aid award because the account is considered their asset instead of yours. This could reduce their financial aid by up to 25% of the asset value.

Coverdell Education Savings Account

A Coverdell Education Savings Account (ESA) has tax advantages similar to a 529 plan in that withdrawals made for qualified education expenses are tax-free. An ESA differs from a 529 in that you are able to self-direct your investments, which may be more desirable to investors who prefer to handpick their securities.

Although this account is generally not as flexible as other plan options, it does allow you to withdraw funds for education expenses prior to college. If you are a parent with children in private elementary, middle, or high schools, withdrawals up to $10,000 from an ESA can be used without penalty.

There are strict income restrictions to open an ESA and there are no gift contributions allowed from other family members or friends. Additionally, the maximum annual contribution is $2,000, which is significantly lower than other alternatives. However, if you’re following the $2k Rule (described above), this account could be a great savings option to meet your needs.