How should I save for my children's college education?

Ask an advisor: I don't have kids yet. Can I still save for their education?

March 9, 2023 7:04 PM

The cost of an American college education has more than doubled since 2000.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

This week, for the first time, we're bringing back a previous guest: the young lawyer who asked about Roth IRAs last week. This time he's planning not for retirement, but for the children he and his wife hope to have in the next few years. Specifically, he's wondering how to save for their education.

The cost of college in the U.S. has more than doubled since the start of the 21st Century. In 2022, the average tuition of a four-year, in-state undergraduate program was $9,377 per year, according to the Education Data Initiative. For out-of-state schools, it was $27,279. And that's not including all the other expenses students incur, including books, supplies, food and housing. With all that included, the average cost of attending an out-of-state college comes out to $44,014 per year — or $176,056 in total.

So if you want your child to receive a higher education, it's important to start saving early. Luckily, there are many financial devices to help do this.

Perhaps the most famous is the 529, a tax-advantaged plan specifically for education savings. Like a Roth IRA, the saver builds this account with post-tax dollars, which can then grow and be withdrawn tax-free — as long as they're used for educational purposes. Originally, 529s were only designed to cover college and university expenses, but in 2017 they were expanded to include K-12 schooling as well.

There are also other options. A custodial account, for example, is similar to a 529 but doesn't have quite the same tax advantages — the savings in them do not grow tax-free, but are only taxed at the child's tax rate.

And in some cases, a Roth IRA itself can be a good option. Once they turn 59½, a Roth saver can withdraw the funds tax-free — and by that time, their child may be college bound.

So when it comes to saving for college, there are many tools to choose from — which can be both helpful and confusing. Our Westchester lawyer turned to this column for guidance. Here's what he wrote:

Dear advisors,

What are the best types of accounts or investments to put towards a child's college fund? My wife and I don't yet have kids, but our goal is to start having children in the next two or three years. I'm 28, and my salary is $135,000. Combined with my wife's income, we make a total of about $220,000 per year. We live in Westchester, New York.

We'd like to get started planning right away. What financial devices would you recommend, and how much and how often should we contribute to them?

—Still wondering in Westchester

And here's what financial advisors wrote back:

A 529 will do just fine

Kristy Jiayi Xu, a certified financial planner and the founder of

Global Wealth Harbor

in Walnut Creek, California

For your question about what financial device to use, a Section 529 savings plan would usually be the best option for parents at your income level. 529 earnings grow tax-deferred, and withdrawals are tax-free as long as they are used for qualified education expenses.

Your income is too high for Coverdell ESAs or Series EE bonds. Custodial accounts are suitable for parents of all income levels, but the accounts are not tax-efficient and are counted as student assets for financial aid, and may terminate before a child enters college.

Trusts are for wealthier parents or grandparents who can transfer appreciating assets or any type of property interests to a trust to pay for additional non-qualified education expenses. In your case, a 529 seems like the best choice.

Roth is right

Greg Goff, a certified financial planner and the founder of

Sound Wealth Management

in Greenville, South Carolina

The Roth IRA could be the best option for this young lawyer and his family to accomplish education savings and retirement savings at the same time. Since they don't yet have kids, they might as well use a tool that can be used for either need.

I typically recommend that clients fund Roth IRAs first, then move on to funding the education plans, such as 529s, since they are more limited in use.

Using a Roth IRA for education can be a smart way to save for college or other education expenses, as long as you keep in mind the potential tax implications and contribution limits. 529 plans can be helpful to supplement any additional need not covered by the Roth IRA. Always consult with a financial advisor or tax professional before implementing these strategies.

Why not a brokerage account?

Noah Damsky, a chartered financial analyst and principal at

Marina Wealth Advisors

in Los Angeles

One path to consider for saving for college is a 529 plan. You could accelerate five year's worth of funding up front in the amount of $170,000 (for a couple, and $85,000 for a gift from an individual). Given the tax-free growth, this could reasonably cover all college expenses in 20+ years if sufficient growth is achieved.

Another option is a taxable brokerage account. Why pay taxes if you can put it in a 529 and not pay taxes on investment growth? I'll tell you why: 529 assets are limited to spending on education, while a general brokerage account is not limited.

If your child happens to receive scholarships, maybe they won't need your 529 at all. That can pose a problem down the line where you could have to pay penalty taxes to take the money out of the 529.

Don't forget about retirement!

Kevin Brady, a certified financial planner and vice president at

Wealthspire Advisors

in New York City

There are two attractive ways to save for future college expenses: a 529 and a brokerage account. But first, you and your wife should further discuss how much you plan to be responsible for and how those savings affect your own retirement savings.

Saving for retirement should take priority, given there are multiple avenues to save for college including a combination of 529 plans, current income, student loans, scholarships, part-time employment. Some couples decide to target paying for 50% of tuition for a private university, or only tuition for a public university, as an example. It is OK to not be completely sure and change your mind as you go, but guardrails help.

Once those are in place, saving for college in both a 529 plan and a brokerage account in your names makes sense. 529 savings can be increased down the road as your income increases, so it is worth it to start with what you can afford.

That said, saving more than $10,000 annually into a 529 generally does not make sense. At that point, saving into a brokerage account is preferable for future flexibility, should you find yourself able to save more than $10,000 a year for college.

Make the most of your 529

Sam Lewis, a certified financial planner and the founder of

SJL Financial

in Wilmington, Delaware

This young lawyer is asking the right questions. Here is a strategy to consider: Open a 529 plan with one of the parent's named as the beneficiary. With the NY529 Direct Plan, they can deduct up to $10,000 from NY State Income taxes (MFJ).

Even though they do not yet have children, they can start funding this account and allow for several years of compounding — and then switch the beneficiary to the child once they are born. This could allow for 20 to 22 years of compounding before the funds are needed, instead of the usual 18 years.

As far as the amount to contribute, I recommend researching the childcare costs they expect to spend once the baby arrives. Many first-time parents are shocked to discover how expensive this is. I had twins, and their infant care costs were more than my mortgage!

If they begin setting that amount aside each month in the 529 plan, it will be less impactful on their budget once childcare costs begin. This is, of course, just a starting point, and they may discover that contributions will be higher or lower in order to reach their goals.