FCCB Blog

College tuition has always been expensive, and the cost is only going up. The average college tuition for the academic year of 2021-2022 was between $27,330 and $55,800, according to the nonprofit CollegeBoard. Saving up for college in advance of it is one of the best things you can do for your child. Fortunately, you have a choice of several different options when it comes to saving for your child’s college education.

Here’s what you need to know about 529 accounts and other popular savings plans for college.

529 savings accounts

A 529 is a tax-advantaged savings plan that is designed to encourage saving for future education costs. These plans, named after Section 529 of the Internal Revenue Code, are sponsored by states, state agencies or educational institutions and are authorized by the federal government.

There are two main types of 529 plans:

• College savings plans. These are savings plans that allow you to invest in a portfolio of stocks, bonds or other securities. The investment returns can grow tax-free. Withdrawals are tax-free as well, as long as they are used for qualified higher education expenses, such as tuition, fees, room and board, books and supplies. The principal portion of withdrawals (the amount you contributed) that are not used for education-related expenses will be subject to income tax. There may be a 10% federal penalty tax on these withdrawals as well.
  
  
• Prepaid tuition plans. These are plans that allow you to pre-purchase tuition credits at participating colleges or universities at today's prices, but use them sometime in the future. The prepaid tuition plan can be used for tuition and mandatory fees, and in some cases room and board.

529 plans are popular for their modest returns with minimal exposure to risk. They’re also widely available and can be opened in one state and accessed in another.

Another benefit to 529s is the lack of annual contribution limits, household income restrictions and required minimum distributions. You can also change the beneficiary of the account to another child if the original named recipient decides they don’t want to attend college after all. Finally, 529 accounts can receive contributions from grandparents or another third party.

Each state also has an aggregate contribution limit for 529 plans, which ranges from $235,000 to $550,000. This amount is established according to the price of attending an expensive college and graduate school program, including the cost of textbooks, room and board.  

Coverdell education savings accounts

Like a 529 plan, a Coverdell education savings account, or ESA, allows you to save for your child’s college tuition on a tax-deferred basis. Withdrawals are tax-free, as long as you use them  for qualified education expenses. In addition, the amount you take out cannot exceed the beneficiary’s yearly qualified education expenses. ESAs can also be used to pay for K-12 education expenses.

Contributions to ESAs don’t qualify for tax deductions or credits. Also, if you take money out of the account for non-qualified expenses, you’ll need to pay federal income tax on the withdrawal, plus a 10% penalty.

ESAs have more restrictions than 529s. First, you can only contribute up to $2,000 annually per beneficiary. Also, if your modified adjusted gross income is $110,000 or more ($220,000 for married taxpayers filing jointly), you can’t contribute to an ESA. Finally, the beneficiary must be under the age of 18 or have special needs when the account is established, and the funds must be completely distributed by the time they reach age 30, unless they have special needs.

Traditional savings account

Believe it or not, an ordinary savings account at the financial institution of your choice can be a great place to save up for your child’s college education. Funds in a savings account can be used for any purpose, and there are no restrictions on the amount you can contribute. There are also no income restrictions for opening accounts.

Returns may be more modest than 529s or ESAs, but savings accounts can be a great complementary savings vehicle for your child’s college tuition. One significant drawback, though, is that there are no tax advantages like those of 529s or ESAs.

Roth IRA

No, these accounts are not just for retirement savings! Many of the components of Roth IRAs make them a great choice for college savings. Withdrawals and returns earned on contributions are tax-free after you turn 59½. If you need the money before that, you can disburse any amount of money you contributed to the Roth IRA at any time without paying any tax or penalties.The earnings on early withdrawals will be taxed, though they will be exempt from the 10% federal tax penalty.

There’s no need to use the funds for education-related expenses and there is no minimum distribution amount until the account owner dies.

However, there are income limits for owning and contributing to a Roth IRA: Your modified AGI must be less than $144,000 for the tax year 2022 to contribute to a Roth IRA, and under $214,000 if you’re married and filing jointly. For tax year 2023, those amounts jump to $153,000 and $228,000 respectively. For 2023, contributions to all IRAs owned by the taxpayer cannot exceed $6,500, or $7,500 for individuals age 50+.

How different college savings plan stack up