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  • Alan Sell

Saving for College

As a Financial Planner in the Sugar Hill, Buford and Suwanee areas, I talk to parents all the time about funding college for their kids. One area that's top of the list of items to address is where and how to start saving.

A College education is valuable, very valuable, in fact. Not only is it a rich experience that in many ways can change the trajectory of a person's life, but it has measurable effects on his or her wallet, too. According to Pew Research, completing a college degree can earn a typical graduate approximately $650,000 more in income over a 40-year career compared with those who have only a high school diploma. But that increased earning power comes at a cost. The Education Data Initiative puts the average cost of attending a public 4-year in-state university at $101,948 over the course of four years. Private universities can be even more expensive.

Understandably, the astronomical cost of higher education causes a great deal of consternation among families looking for ways to pay the bill. However, there are actually several ways to find funds and/or reduce the cost of college. If you're just getting started exploring ways to pay for college or you'd like an overview of the potential sources of funding, you might want to explore our post here: How to Fund College: A Framework and a Timeline. In this post, we'll be exploring one of the most important sources of funds: Savings.

Before we get started, there are two main considerations when it comes to evaluating your options for college savings: tax advantages and impact on financial aid. Below, we'll break down four of the main ways families save and discuss their implications on both aid and taxes. Please note that the details are complicated, and what follows is an overview, not specific advice. Consult a tax professional to discuss your personal situation.

Option One: 529 Plans

529 Plans are one of the first types of accounts that come to mind when college savings is being discussed, and for good reason. They have excellent tax advantages, potential for growth in the account, and no annual contribution limits. That doesn't make them the surefire best approach for savings, but they are the easy front-runner for many families.

How they work:

Each state administers its own 529 Plan. Don't let that fool you, though; savers can have a 529 plan in a state they don't live in. Since each state runs its own plan, the fees and investment options available for savers are different depending on which state they choose. We'll discuss further below, but each state also typically provides tax breaks for residents who contribute to their state's plan. Because there is so much variance between the states, a good bit of research is needed to decide which state's program to choose. Also, 529 plans are owned by the donor, not the beneficiary. This means that the beneficiary can be changed to another family member if there are unused funds.

Tax Advantages:

While there are no annual contribution limits, account owners do need to be aware that yearly contributions in excess of $16,000 per donor in 2022 could be subject to gift taxes. Contributions are not tax-deductible at the federal level, but earnings are tax-free and are not subject to tax when used to pay for qualified education expenses. In the last few years, the list of qualified expenses has expanded to include elementary and secondary schools (up to $10,000 per year) as well as student loan repayments. Over 30 states also offer full or partial tax deduction or credit for 529 Plan contributions, but the details vary widely from state to state.

Financial Aid Implications:

The person who owns the 529 Plan account affects how it is considered for financial aid. If the parent is the owner, the account is considered a parent asset on the FAFSA. Any assets beyond the roughly $10,000 that falls under the Asset Protection Allowance will reduce the student's aid package by up to 5.64% of the asset value. If the account is owned by the student, however, the financial aid package will be reduced by 20% of the asset value. Occasionally, a grandparent or other relative may open a 529 plan for a student. In this case, the assets are not included on the FAFSA (and therefore should not reduce a student's aid package), but families should still be careful with these accounts. Withdrawals from the account are counted as income to the student, reducing aid by 50% of the amount of income. There are strategies to avoid this, but it's important to work with a qualified financial professional to ensure proper steps are followed.

Option Two: UGMA/UTMA Account

How they work:

A UGMA or UTMA Account is a custodial account. The account is owned by the child, but the parent retains control until the child becomes an adult. Any funds contributed to a UGMA/UTMA account must be used for the benefit of the child. Once the child becomes an adult (at age 18 and 21 for most states), the account becomes fully under the control of the child. The drawback for some families is the lack of control the parent has over how the assets get spent. If the child doesn't need all the funds for education, they can't be transferred to another child. Also, once the child reaches adulthood, the account is completely theirs to use how they wish, regardless of their parents' wishes. UGMA/UTMA accounts can be opened at most brokerage firms or banks. Accounts can be invested in a wide range of ways, limited mainly by the options at the institution that holds the account.

Tax Advantages:

UGMA/UTMA accounts are owned by the child, so typically, the child's tax rate will apply, rather than the parent's. Often, up to $1,050 in earnings are tax-free, and the next $1,050 is taxable at the child's rate. Earnings over $2,100 are taxed at the parent's rate.

Financial Aid Implications:

UGMA/UTMA accounts are counted as the student's asset on FAFSA, and can reduce financial aid packages by 20%.

Option 3: Coverdell ESA

How they work:

Coverdell Educational Savings Accounts have flexible investment options, which can be attractive to investors who prefer greater control in their investment accounts.

They have somewhat lower contribution limits at $2000 per year, and higher-income taxpayers may not be able to contribute. The income limit is $110,000 for single taxpayers and $220,000 for joint returns. Beneficiaries can be changed on a Coverdell ESA, but it could be a difficult process. Some ESA agreements provide that only the current beneficiary, after reaching legal age, has the right to change the beneficiary on the account. Also, due to rules around contributions, it can be more difficult for a grandparent to own an ESA for a child.

Tax Advantages:

There's no state or federal tax deduction for contributing to a Coverdell ESA, but earnings are tax-free, and withdrawals are tax-free as long as they're used to pay for a qualified education expense. However, unused funds have to be withdrawn when the child reaches 30 years old, and if the child doesn't have qualified education expenses that year, the withdrawal will be subject to tax and a 10% penalty on the earnings.

Financial Aid:

For the FAFSA, a Coverdell ESA is treated as a parent asset, meaning that after the Asset Protection Allowance, financial aid will be reduced by up to 5.64% of the asset value. Due to the difficulty in having a grandparent own a Coverdell ESA, it's not common for the account to be counted as belonging to someone other than the parent.

Option Four: Roth IRA

How they work:

Typically thought of as retirement savings vehicles, Roth IRA's can be used to save for college as well. While the general rule of thumb is to handle your retirement savings first, and then take care of education savings, there can be reasons to use a Roth IRA for college savings. One benefit is that they do enjoy some tax and financial aid perks, which we'll discuss below. Another is that you can invest in a wide variety of securities with a Roth IRA, usually only limited by the institution you choose for the account. Lastly, if you don't end up using all the funds for education, the remainder stays in your account for retirement savings.

Tax Advantages:

There's no tax deduction for contributing to a Roth IRA, but earnings grow tax-free. You can withdraw up to the amount you contributed to a Roth IRA at any time and for any purpose, tax- and penalty-free, but earnings in the account are a different story. When you make a withdrawal of the account's earnings for retirement purposes, it's tax free, but for qualified education expenses, it's only penalty-free. That means you'll pay income taxes on the distribution, but the 10% early withdrawal penalty is waived.

Financial Aid Implications:

Assets in a Roth IRA are not a part of financial aid calculations, so your financial aid package won't be reduced because of assets held in a Roth IRA. However, withdrawals will be counted as student income, reducing aid packages by 50% of the amount of the withdrawal. There are strategies to work around this, including timing withdrawals in such a way so as to minimize impacts on aid.


Of course, there are other options besides just these four savings vehicles. You could open a savings account at a bank, or just stuff your mattress with cash. But for savvy investors, the four account types we've discussed here are some of the major ways parents set aside money for their children's education needs. If you would like to discuss strategies specific to your own family, don't forget to reach out to a financial professional.

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