College savings options guide for how to save for your kid’s college

There are many more choices available for funding your kid’s college tuition than are usually discussed. Here are ten options I recommend you consider — and the best use cases for each of them!

What’s most important to your family?

As always, the best place to start is by identifying what your family’s goals are. How important is growth, flexibility, or early access to the savings for pre-college college expenses?

Consider each of these questions:

Will saving for your kid’s college expenses prevent you from achieving your retirement/goals?

If there is an emergency , is there a chance you will need to access this money before your kid starts college?

How much risk can you tolerate (and how much growth potential are you looking for)?

Do you plan to pay for private pre-k, elementary school, or high school tuition prior to college?

If your kid does not end up needing the money, would you want to use the savings for another family member’s college expenses?

I want to be very clear, I do not recommend under-funding your retirement in order to save for your kid’s college expenses. Your kid might choose to not go to college or may receive a scholarship. As a worst case scenario, your kid could pay for their college expenses with loans, but you cannot fund your retirement with loans.

Don’t only save, be sure to manage costs.

Below, I’ll walkthrough a detailed breakdown of savings options. But, it should also be noted that the other side of the financial equation is just as important — managing the costs of college.

Consider each of these factors when choosing a school.

Is going to college necessary? Are there other, less expensive options for your kid to achieve their goals?

Is there a school of sufficient quality that would cost significantly less? With colleges, remember that higher price doesn’t necessarily equal higher quality.

Are there merit-based opportunities for reducing school cost? (e.g. merit-based institutional scholarships, merit-based third-party scholarships, work-study programs, assistantships)

Are there need-based opportunities for reducing school cost? (e.g. Federal financial aid through the FAFSA program, need-based institutional scholarships, need-based third-party scholarships)

College savings account options

If you think your kid is likely to go to college and you’re able to simultaneously fund your retirement…

1. Education Savings Account (ESA)

Best feature : In addition to use for college expenses, funds can be withdrawn tax- and penalty-free for broad range of K-12 expenses.

Worst feature : No income tax deduction for contributions, maximum income limits apply.

Ideal use case : If you are starting your savings early (there’s a $2,000 annual contribution limit), may want your kid to attend private primary school, or value self-directing the investments.

2. 529 plan

Note: can be used in combination with an ESA, you don’t have to only choose one. Also, most states do not require you to be a resident to use their 529 plan, so you can shop for the one that’s best for your family (but using another state’s plan may affect your state income tax deduction for your contributions).

Best feature : Income limits do not apply and some states offer state income tax deductions for 529 contributions.

Worst feature : You must choose a portfolio from the options available in your plan.

Ideal use case : If your income is too high to use an ESA, you would benefit from a state income tax deduction, or if you want to save more than the $2,000 annual maximum that ESAs allow.

A 529 plan variation to consider: a grandparent-funded 529 plan.

If you’re concerned that your college savings might disqualify your family from need-based financial aid, the kid’s grandparent could open the 529 plan instead of the parent.

Note that annual income is one of the larger factors in determining if a student qualifies for need-based financial aid. So, this maneuvering may not guarantee need-based aid eligibility if you are perceived to be a high earner. Credit to Debbie Schwartz from Road2College for our conversation about this creative option.

3. State prepaid plan

Best feature : “Lock-in” your kid’s future tuition price by pre-paying it, plan may earn your kid in-state tuition even if you move out of state , and plan may be guaranteed by your state.

Worst feature : Low/no growth opportunity for your contributions.

Ideal use case : If you think your kid is likely to go to college in a state that offers prepaid plans and you are not interested in the growth possibilities that ESAs and 529 plans offer.

4. Private 529 plan

One other 529-related option to consider is a “private 529 plan.” This is an interesting option if you think your kid is likely to choose one of the (nearly 300) participating private colleges or universities on the list.

One thing to note — this option is a bit of a misnomer. It’s not an investment account like the state 529 plans, it’s more like a prepaid tuition plan. You can learn more about the private 529 plan here.

Best feature: Allows “locked in” tuition re-payment at participating private universities

Allows “locked in” tuition re-payment at participating private universities Worst feature: Low/no growth opportunity

Low/no growth opportunity Ideal use case: If you are confident that your kid will attend a participating private university and you’re not interested in an ESA or 529

If you want extra flexibility or think your kid is not likely to need the money for their college costs…

5. Taxable brokerage account

Best feature : Very flexible, can be invested however you’d like and accessed without penalty (taxes may apply).

Worst feature : No tax advantages.

Ideal use case : If you are already maxing out all tax-advantaged retirement accounts and think your kid may not go to college or is likely to get a full scholarship.

6. High-interest FDIC-insured savings account

Best feature : Virtually no risk, extremely liquid and flexible.

Worst feature : No tax advantages, limited growth potential.

Ideal use case : If you want maximum flexibility because you may need the money early, your kid may not need the money for college expenses, and your timeline is too short to invest in the stock market.

7. Roth IRA

Best feature : Growth is tax-free if you wait to make a withdrawal until you are 59½, but contributions can be withdrawn without penalty or taxes before then.

Worst feature : Contributions are not tax deductible.

Ideal use case : If you’re adequately funding your retirement elsewhere and would like to save even more, but there’s a small chance might want to access the funds early for your kid’s college.

8. Traditional IRA

Note: if you have a different pre-tax retirement account from an old employer (like a 401(k)) that you do not need to fund your retirement, you could convert it to an IRA to access for qualified education expenses.

Best feature : Contributions are tax deductible, money can be withdrawn early without penalty for qualified education expenses (may incur taxes).

Worst feature : You will still pay taxes on any growth, so you’re better off with an ESA or 529 if you think you’re likely to use the money for education expenses.

Ideal use case : If you’re adequately funding your retirement elsewhere and would like to save even more, but there’s a small chance might want to access the funds early for your kid’s college education.

9. Real estate rental property

This one requires a brief explanation. I’ll credit Paula Pant from Afford Anything with this idea. If you buy a rental property on a 15-year mortgage when your child is very young, you’ll have a paid off rental property when they go to college!

You can then either sell the property and use the lump sum to pay for college expenses, or you can use the rental income to cash flow college expenses.

Best feature : Many tax deductions available , no penalty if you don’t end up using the money for education-related expenses.

Worst feature : Much more hands on than the other options. Higher transaction costs than the other options.

Ideal use case : If you’re already saving for retirement and you’re interested in owning rental property.

10. Home equity

Finally, you could choose to use your earmarked “college savings money” to pay extra on your mortgage. Then, when it’s time for your kid to go to college, use a home equity loan or line of credit to pay for the college expenses. This option can be dangerous if done without planning — you don’t want to take on more debt than you can handle or delay your retirement plans significantly.

If done strategically, this can be a great choice. Home equity loans tend to have lower interest rates than traditional student loans. Plus, home equity is not included in FAFSA calculations (the financial aid application) so this can be a good option if you think you might qualify for need-based financial aid.

Best feature: Protects your savings FAFSA visibility; great flexibility if you end up not needing the funds for college expenses

Protects your savings FAFSA visibility; great flexibility if you end up not needing the funds for college expenses Worst feature: You won’t benefit from the higher compound growth possible with an ESA, 529 plan, or taxable brokerage account

You won’t benefit from the higher compound growth possible with an ESA, 529 plan, or taxable brokerage account Ideal use case: If you have a lower income and you’re likely to qualify for need-based financial aid and/or if you’re not sure if you’ll use the funds for college education expenses

If you are not able to simultaneously fund your retirement while saving for your kid’s future college expenses…

11. Student loans

Best feature : Pay later, not now. You don’t have to save ahead of time.

Worst feature : You’re paying interest on the college expenses.

Ideal use case : If you had to prioritize your retirement savings over saving for college expenses.

One thing worth noting — private student loans that don’t require a cosigner are now available. So, while student loans wouldn’t be my top recommendation, college funding may still be feasible even if you need a loan and don’t have someone to cosign.

Comparisons

If viewing on mobile, click here to view the full table.

Traditional college funding approaches

Tax Advantage Penalties for non- qualified withdrawal Growth/ upside Options if funding is not used Liquidity for other uses ESA Contributions are not tax deductible. Tax-deferred accumulation and tax-free withdrawals for qualified expenses. 10% penalty + deferred taxes. Self- directed investments but maximum annual contribution of $2,000. Must be used by the time the kid is 30. If not, must be given to them or rolled into an ESA for another family member. Not liquid for non- qualified use, if you want to avoid the penalty. 529 plan Contributions may be state income tax deductible. Tax-deferred accumulation and tax-free withdrawals for qualified expenses. 10% penalty + deferred taxes. Choose from the portfolio options available in your plan. Check with your plan provider. Typically, there is no age restriction for beneficiary. Can be rolled into a 529 for another family member. Not liquid for non- qualified use, if you want to avoid the penalty. State Prepaid Varies; possible state income tax deduction for contributions. Varies; possible penalty if kid goes to out of state school. None; you are just pre-paying. Varies; possible full reimbursement plus small amount of interest, possible small penalty Not liquid. Private 529 plan Varies; possible state income tax deduction for contributions. Varies. “Growth in value” if cost of tuition increases after you have pre-paid. You can use the funds for a family member’s qualifying expenses or get a reimbursement, possibly subject to penalty and taxes. Not liquid for non- qualified use, if you want to avoid the penalty. Student loans In many cases, the interest part of your loan payments is tax- deductible (but the tax savings will be less than the interest you are paying). N/A. None. You won’t take out the loans until they’re needed. N/A (not used until needed).

Alternative college funding approaches

If viewing on mobile, click here to view the full table.

Tax Advantage Penalties for non-qualified withdrawal Growth/ upside Options if funding is not used Liquidity for other uses Taxable brokerage account None. None, but you may incur taxes if you realize capital gains. Self- directed. Can be used for anything. Very liquid. Will only require selling funds. (Subject to volatility.) Savings account None. None. Set interest rate/ growth. Can be FDIC insured. Can be used for anything. Very liquid. Roth IRA Growth is tax-free if you wait until 59½. Contributions can be withdrawn penalty-free before 59½. 10% penalty + deferred taxes (if you withdraw more than your contribution total for non- qualified expenses). $6,000 contribution limit in 2019. Self- directed investment options. Use on your own retirement expenses after age 59½. Or, withdraw contributions penalty-free at any age. Fairly liquid if accessing your contributions but will require selling funds. Full balance is accessible after 59½. IRA Contributions are tax- deductible. Growth is tax-deferred. You can avoid the penalty on withdrawals for post- secondary tuition expenses (you may owe income taxes). 10% penalty + deferred taxes. $6,000 contribution limit in 2019. Self- directed investment options. Use on your own retirement expenses after age 59½. Not liquid for non- qualified use, if you want to avoid the penalty. Exception is SEPP/72(t) rule. Then very accessible after 59½. Real estate / rental property Several tax deductions available. None. Rental income, property value may rise. Hold the rental property for continued rental income, sell, or take a home equity loan. Somewhat liquid. Transaction costs may apply. Home equity None. None. Saving on mortgage interest by paying early, increase in home value increases your available funds. Do nothing and have the mortgage paid off sooner, sell, or take a home equity loan. Somewhat liquid. Transaction costs may apply.

Most of these options will affect your financial aid eligibility. Some of the options, like the IRAs, have income eligibility rules. The tax-advantaged accounts have varying interpretations of what costs are qualified college expenses and who can qualify as a beneficiary. Once you have your choice in mind, I recommend doing your own research or speaking with a tax professional to confirm you are being as efficient as possible.

At the end of the day…

If you think your kid is highly likely to use the college savings, I really like the ESA and 529 plans. The ESA is great if you may have education expenses for private school before college. The 529 is amazing because it can be double tax advantaged — state income tax deduction plus no tax on the growth when used for qualifying expenses!

If you are a big saver with a low-to-moderate income (so you think your family may qualify for need-based aid), using the grandparent-funded 529 or home equity strategy may be worth considering.

If you are uncomfortable with investing or your kid will be going to college in the next few years (so you won’t be able to invest for a long time horizon), the private 529 plan or state pre-paid plans may also be worth considering. These options assume you are fairly certain about the type of institution (private vs public) that your kid will attend.

After considering all of the options, what are your plans for college savings?

Related posts from Semi-Retire Plan:

College funding references and further reading:

General college funding

ESA

529

State prepaid

Taxable brokerage

Student loans

Savings Account

Roth IRA

IRA

Real Estate Rental