Financial advisors say retirement savings should take priority over saving for your child’s college education, but, especially in this economic climate, it may be difficult to contribute to your 401(k) or IRA alone, let alone to college savings.
No matter how old your child is, you do have options when you’re ready to save for education. Even if your child will soon be on their way to college and you haven’t saved a dime for them, it may not be too late to gather the funds they’ll need.
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Your Baby’s Savings
If you have the luxury of starting college savings early, soon after or even before your child is born, you can to open a 529 college savings plan, set your investment allocations, use automatic payment plans and watch your money grow.
A 529 plan is a tax-advantaged account in which you contribute after-tax dollars to invest in mutual funds or other investment vehicles for your child’s education, much like you would in a Roth IRA or a Roth 401(k). You choose where to invest based on when you'll need the money, and how much market risk you’re willing to handle. The maximum contribution is $65,000, or $130,000 for married couples, over a five year period. You won’t be subject to a gift tax, which is usually required for gifts of more than $13,000 per year.
If you max out your 529 contributions, you can also put away money in a Coverdell Education Savings Account. However, the more money you make, the less you can contribute, and the maximum contribution is just $2,000 per year. Also like the Roth, you contribute after-tax dollars to these accounts and are not taxed on the growth as long as the funds are used for school. You will pay taxes, however, if you use the money for something else (like a classic Camaro). On the plus side, the money can also be used for your child’s education from kindergarten until they’re a senior in high school as well.
On the Road to Higher Education
If you haven’t been able to save for your child’s education until they’re on their way to middle school, you still have time. If you haven’t opened a college savings account, do so as soon as you can.
“You may want to go with a 529 Plan, which allows much larger lump sum contributions and may give you a chance to make up for lost time,” advises Mary McConnell, director of college savings products at Schwab (Stock Quote: SCHW). “Has anything changed in your life? A new baby? A better-paying job? Consider these changes and recalculate your needs. Contribute any windfall money to your college savings account.”
You may also want to consider opening a custodial account, which holds funds in your child’s name and which you control until they reach 18 or 21. This way, you can teach your child about investing by watching their money grow with compounded interest. .
One major drawback to the custodial account is that once your child reaches the age where they gain control of the funds, they can use the money however they want. It doesn’t have to be for college, so you’ll want to contribute only as much as you’re comfortable with.
