How to Start a College Fund for Your Kids

By F. F. John , last updated December 22, 2011

It is crucial for every parent to understand how to start a college fund for their kids. College costs have continuously skyrocketed each year. In 2010, for instance, college tuition rose faster than the national gross domestic product. And, because college tuition increases by about 5 percent every year, by 2021, tuition at a private college will cost about $63,571 while tuition at a public institution will cost $50,359. To prepare for when your child goes off to college, consider the following factors and options.

When Will Your Child Go To College?

You must figure out when your children will need money for college. The average college student begins school at 18 years old. As such, you need to consider how many additional years you have to save the funds needed to contribute to your child’s college tuition costs. When you determine how many years you have until your child goes to college, you must consider which option is best to start a college fund.

529 Plans

One way to create a college fund is to start a 529 account. These accounts are specifically for college saving and were created by federal law. Almost every state has a 529 plan that can be used by both residents and non-residents alike. As long as the money is used for education costs, the withdrawal is tax-free. There is, however, a lifetime contribution cap that is anywhere between $235,000 and just above $300,000, depending on the state. 529 accounts allow for tax benefits and, in most cases, you receive higher tax benefits if you use your state’s program. Once you decide on which state’s 529 plan you will use, visit its website and fill out the application form. You will then have to mail a check deposit for the account.

Coverdell Education Savings Account

Originally called the Education IRA, a Coverdell Education Savings Account (ESA) allows you to save up to $2,000 of post-tax dollars every year, tax-free. Additionally, any withdrawals from the ESA are tax-free as long as the money goes toward education costs. Contributions can be made until your child is 18 and withdrawals can continue until age 30. At that point, the account owner will be charged a 10 percent tax penalty for every withdrawal and the money removed will be taxed as personal income. Corporations can also contribute to the account. Although you open the account and control it as a custodian, you can turn it over to your child and make her the account owner at age 18. However, be aware that your child’s ownership of the ESA can impact their eligibility for financial aid. This is because the money in the account is considered income that can eliminate your child from consideration for need-based scholarships and grants. A financial advising firm is needed to create an ESA.

Uniform Gift to Minors Act & the Uniform Transfers to Minors Act

The Uniform Gift to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) are custodial accounts that you can set up for your minor child. Depending on the state of residence, once your child turns 18 or 21, the account’s ownership transfers to them. The UGMA allows a minor to own securities without a formal legal document or a court-appointed trustee. The UTMA allows minors to own other types of properties including patents, real estate and royalties. Like the Coverdell ESA, both the UGMA and UTMA can affect your child’s eligibility for financial aid. Any transfers to your child should be completed with the assistance of an attorney.

Bank Saving Accounts

You can also open a savings account at your bank for your child’s college fund. In fact, if you save $100 per month at a 4.5 percent interest rate can generate more than $33,500 by the time your child is 18, according to Bank of America. Keep in mind that you may not need to save the entire cost of your child’s college education as she may be able to access loans, scholarships and grants to pay the balance. Still, being able to make a contribution, no matter how small, goes a long way.

Traditional Investments

Investment structures like mutual funds and stocks are another way to create a college fund for your child. For mutual funds, it is best to choose one that has a three to five year track record and does not have high expenses. If your child is eight or younger, consider parking 60 to 90 percent of your invested money in stocks, in anticipation of college. Thus, look for a mutual fund that invests primarily in stocks versus bonds. By the time your child is aged between nine and 13, it is time to invest in more bonds over stocks. And by the time she turns 14, begin to shelter the earnings made from your investments. A reputable and experienced financial adviser will assist you in using traditional investments to save money for your child’s collegial aspirations.

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