How to Save for College: Tips for Parents

Article summary

• Explore diverse savings options for parents: Families can maximize savings by starting early and utilizing tax-advantaged accounts like 529 plans, prepaid tuition plans and Coverdell ESAs, while being mindful of how custodial accounts might impact financial aid eligibility.
• Leverage grandparent contributions strategically: Grandparents can help by opening their own 529 plans (which no longer count as student income on the FAFSA), contributing to parent-owned accounts or paying tuition directly to the institution to avoid gift tax issues.
• Choose flexible solutions for student savers: Students saving for their own education should consider high-yield savings accounts for short-term goals or Roth IRAs for flexibility, but they must remain aware that student-owned assets are assessed at a higher rate for financial aid purposes.

How much should I save for college?

College costs vary widely today. Public four-year in-state tuition and fees average about $12,000 a year. Out-of-state tuition averages around $32,000, while private schools can exceed $45,000 annually. Room and board, books and other costs also add up.

Figuring out how to save for college depends on who’s doing the saving and when they start.

Whether you’re a parent planning ahead, a grandparent looking to help, or trying to save for your own education, the best way to save money for college depends on your timeline, tax situation and goals.

Ways to save for money for your child’s college education

There’s no single best way to save for kids’ college, but starting early and using tax-advantaged accounts helps many families.

• 529 college savings plan: This investment account offers tax-free growth and withdrawals for qualified expenses with high contribution limits, usable at most accredited schools, and the account owner keeps control.
• Prepaid tuition 529: Lock in today’s tuition rates at participating schools. They’re helpful if you’re confident about where your child will attend.
• Coverdell education savings account (ESA): This custodial account has smaller contribution limits ($2,000/year) but greater investment flexibility and can cover K-12 expenses. However, income limits apply.
• Custodial account (UGMA/UTMA): UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts can hold financial assets and property and are transferable to the child at age 18 or 21. But they don’t offer education-specific tax breaks and may affect financial aid more than other savings plans.

Under the old Free Application for Federal Student Aid (FAFSA) formula, parent-owned 529s were assessed at up to 5.64% of their value. Under the new Student Aid Index (SAI) formula, families with more than one child attending college may receive less financial aid than before. However, parent assets are still weighted much more lightly than student assets, which can be assessed at roughly 20%.

A common question is, “How much should I save for college?” The answer depends on your goals and timeline. Using a college savings calculator can help set a target. For example, saving $250 a month from a child’s birth until 18 can grow to nearly $100,000 at a 7% rate of return.

How grandparents can help grandkids save for college

Grandparents have more ways to save money for college than they may realize, and recent FAFSA changes have made some options more attractive.

• Grandparent-owned 529: Grandparents open and control the account, which continues to earn tax-free growth. Under updated FAFSA rules, distributions from grandparent-owned 529s no longer count as student income.
• Contribute to a parent-owned 529: Grandparents can also just contribute to an existing 529 account that the parents control. However, speak with a tax expert to understand any potential gift tax consequences.
• Pay tuition directly: Grandparents can also make direct payments to their grandchild’s college for tuition. Tuition payments don’t count against annual gift tax exclusions and won’t reduce need-based aid eligibility under current rules.

Coordinating strategies with parents can help maximize tax benefits and financial aid, while keeping things simple for the student.

Saving for your own college education

For young adults figuring out how to save money as a college student or for future schooling, options may depend on timeline and flexibility.

With a shorter timeline, lower-risk options can make sense. And, for those trying to balance school savings with other priorities like building an emergency fund or paying down credit card debt, flexibility matters.

• High-yield savings account: These accounts help save money needed in the next 1 to 3 years. Funds are easily accessible, and higher rates make them more attractive than a traditional savings account.
• Roth IRA: Contributions can be withdrawn anytime, tax and penalty-free, at any age. Earnings can also be withdrawn without the 10% early-withdrawal penalty if used for qualified higher education expenses, but they are still taxed as income, and withdrawals can reduce your future retirement savings. Carefully review the pros and cons.
• Student-owned 529: Students who know they’ll continue their education can open or take ownership of a 529 plan to keep saving in a tax-advantaged way.

It’s important to note that student-owned assets and income are assessed at a higher rate on the FAFSA than parent assets. Up to 20% of students’ non-retirement assets, like checking, savings and brokerage accounts, count toward expected family contributions. And for any student income over a set maximum, the contribution rate is 50%. These are much higher than the rates applied to parent-owned assets.

For students who expect to qualify for need-based aid, such as work-study programs, scholarships and federal, state and institutional grants, where you hold your savings matters.

Put your college savings plan into action

Regardless of where you are with your educational savings journey, you have options. The right approach depends on your role, timeline and goals. But starting early and using tax-advantaged accounts can make a significant difference.