Ways to Save for College: 529s, Coverdells, Roth IRAs and More

With college costs rising over the years, saving for your child’s education can feel overwhelming. But you don’t have to save the full cost of college to make a meaningful difference. Every dollar saved is a dollar your child won’t need to borrow, and starting early allows your savings to grow over time. Understanding the main savings options helps you choose the right approach for your family.

529 plans

529 plans are tax-advantaged savings accounts designed specifically for education. They’re named after the section of the tax code that created them and are offered by states and some educational institutions.

The main benefit is tax treatment. Earnings grow without federal income tax, and withdrawals for qualified education expenses are tax-free. Many states also offer a state income tax deduction or credit for contributions, especially if you use your own state’s plan, which can provide additional savings.

Qualified expenses generally include tuition, fees, books, supplies, required equipment and certain room and board costs for college and other eligible postsecondary institutions. 529 plans can also be used for some K-12 tuition and apprenticeship program costs, and to repay a limited amount of student loans, within federal limits. Rules can change, so check current guidelines.

529 plans have high contribution limits, no income limits for contributors and allow anyone, such as parents, grandparents or friends, to contribute. The account owner keeps control of the money, and the beneficiary can be changed to another eligible family member if the original beneficiary doesn’t need the funds.

If money is withdrawn for non-qualified expenses, the earnings portion is generally subject to income tax and a 10% penalty, with some exceptions, such as if the beneficiary receives a scholarship. Under federal rules, unused 529 funds may also be rolled over to a Roth IRA for the beneficiary, subject to lifetime limits, annual contribution limits and requirements such as the account being open for at least 15 years.

Coverdell Education Savings Accounts

Coverdell Education Savings Accounts also offer tax-free growth and tax-free withdrawals for qualified education expenses. One advantage is flexibility, since Coverdell funds can be used for a wide range of K-12 expenses as well as college.

However, Coverdells have significant limitations. Annual contributions are capped at a low amount per beneficiary, and there are income limits for contributors, so higher earners may not be able to contribute directly. Funds generally must be used by the time the beneficiary reaches age 30, with exceptions for special needs beneficiaries.

Roth IRAs

Roth IRAs are retirement accounts, but some families use them as a flexible way to save for college. Roth IRA contributions, not earnings, can generally be withdrawn at any time without taxes or penalties. Earnings withdrawn for qualified higher education expenses may avoid the 10% early withdrawal penalty, though income tax may apply if other requirements aren’t met.

The advantage is flexibility. If your child doesn’t need the money for school, it remains in your retirement account. The downside is that using retirement money for college means less for retirement, and Roth IRAs have income limits and annual contribution limits.

Custodial accounts

Custodial accounts, known as UTMA or UGMA accounts depending on the state, hold money or investments for a minor. Funds can be used for anything that benefits the child, not just education, offering more flexibility than 529 plans.

However, the money legally belongs to the child and becomes theirs to control at the age of majority set by state law, typically 18 or 21. At that point, they can use it for any purpose. Custodial accounts are considered the student’s asset for financial aid purposes, which can reduce aid eligibility more significantly than parent-owned accounts. Income may also be subject to the kiddie tax.

Financial aid considerations

How savings affect financial aid depends on who owns the account. Parent-owned 529 plans are generally treated more favorably for federal financial aid than assets owned by the student. Under federal aid formulas, parent assets are assessed at a much lower rate than student assets.

Under the simplified FAFSA, distributions from grandparent-owned 529 plans are no longer counted as student income, making them more favorable than in the past. Financial aid rules can be complex and vary between schools, especially for institutional aid. Check with a school’s financial aid office about how different accounts are treated.

Other ways to reduce college costs

Saving is only one part of paying for college. Scholarships, grants, work-study, starting at a community college, choosing in-state public schools and earning college credits in high school through dual enrollment or Advanced Placement courses can all reduce costs.

Retirement first

Many financial planners suggest making sure your own retirement is on track before focusing heavily on college savings. Your child can borrow for college through student loans, but you can’t borrow for retirement. Sacrificing your retirement savings could leave you financially dependent on your children later. Ideally, balance both goals based on your family’s situation.