The cost of college is on the rise, and no generation knows that better than millennials. Many young parents today are still paying off their own student loans; while trying to save for their children’s education. The good news is, starting a college fund while your child is young gives you a good amount of time to create a solid nest egg for their future. The decision now is where to put your money?
For many parents considering how to start a college fund for their child, the first step may be a savings account at a local bank. It’s an easy way to put money aside for the future. Most banks will let you open a savings account with a small deposit and you can set up automatic transfers from your checking account to keep the fund growing. Interest rates for savings accounts are relatively low, providing about 2 percent annual percentage yield (APY).
There is really no risk of losing your money with a savings account, as long as you choose a bank that’s federally insured. So, if your bank does happen to fail, the account is safe up to $250,000. Another benefit of a savings account is easy access to your money.
There are no penalties if you decide to use the account for a vacation instead of an education. But that may also be a temptation. So, if you’re likely to blow every penny on a trip to Disney World, this could be the wrong savings vehicle for your family.
For investors with a higher tolerance for risk, mutual funds may be a good path to save for college. Mutual funds offer diversification and potential for rapid growth, allowing your money to work harder. They are also easy to buy and sell through a broker or online account.
However, mutual funds distributions could mean you’re paying capital gains taxes on your investment every year, even if you don’t sell your shares. And when you do sell the fund to pay for college, you’ll pay taxes again. Speaking of college expenses, if you need to sell part or all of the mutual fund to pay your child’s college bill by a specific date, you could find yourself at the mercy of a down market swing. Another thing to remember, if the mutual fund account is in your child’s name, it could reduce their financial aid eligibility by 20 percent.
Coverdell savings accounts gained popularity because the funds grew tax-free and could be used for elementary and secondary education expenses, as well as for college. However, many 529 plans, such as the NC 529, have changed their rules recently, to allow funds to be used for K–12 tuition at public and private schools.
ESAs also have strict contribution limits. You can’t deposit more than $2,000 per student, per year. And when the student turns 18, they take control of the account. That means the student can spend the money on anything they want, like spring break in Hawaii.
Almost every state, including North Carolina, has a tax-advantaged 529 education plan. The name refers to section 529 of the Internal Revenue Code (IRC). The plans were added to the IRC in 1996 to encourage saving for higher education. The Tax Act of 2017 now allows the funds to be used for K–12 tuition. Financial experts say 529 plans are the smartest way to save for college.
Although 529 plan contributions cannot be deducted from your federal income taxes, the earnings grow tax-free and withdrawals are not taxed if they are used to pay for qualified education expenses. Those include:
Investment options for an NC 529 Plan include mutual funds and cash reserves, to match your investment risk tolerance. Choose to be more hands-on with your investments or select an age-based portfolio that automatically moves funds out of riskier stocks and into bonds and cash reserves as the time for college draws near.
Other benefits of an NC 529 education plan:
For parents of very young children, you might be asking yourself, “What if my child doesn’t end up going to college?” No problem. Your 529 funds can be transferred to a sibling or another family member. Or you, yourself, may decide to go back to school, and the money will be there for you. If your child decides to pursue a career in cosmetology, automotive, or other industry, a college savings plan also can be used to pay for trade or technical school.
The bottom line is, the sooner you start saving for college the more time the funds will have to grow. To learn more about how to start an NC 529 college fund for your child, visit https://nc529.org/nc-529-plan-questions/.