Saving for college in today’s world is a big challenge, especially given the costs.  The expenses surrounding a college education today are astounding. According to CollegeData.com, the average annual cost of a four-year private college is $49,320 per year, and public colleges can cost an average $9,650 for in-state residents, and $24,930 for out-of-state residents. How do you know what to save and ensure that your kids are able to pay for college without incurring a huge debt-burden?

The best advice is to start saving as early as possible. Are you pregnant? Start now! Additionally, encourage your friends and family to help you along the way. Every penny will help and the sooner you start, the better you can take advantage of the miracle of compounding.  If you push off saving, your child will incur more debt.  You note that I said, “Your child will incur.”  Don’t use your retirement money to help pay for your child’s college.  Remember, they are young and can borrow or apply for financial aid; you cannot borrow or get a scholarship for retirement.

Three Ways To Save For College

529 College Savings Plans:

A 529 college savings plan operates in a way similar to an IRA or a 401(k) plan. As such, the government provides a way for you to save for your child’s higher education tax-free through several savings options, from more aggressive to more conservative.  These plans offer significant tax advantages allowing any gains on the accounts to be tax-deferred. (Once the funds are used to pay for qualified expenses, the parents will not pay taxes on those funds. Also, you pay no federal taxes on your account’s earnings, and there may be state tax benefits as well.)

The investment within a 529 college savings plan is tied to the stock market, so the account is not guaranteed and will fluctuate. Many people saw their 529 savings plummet during the 2008 recession, and if they needed the money for their college student at that point, they didn’t have time to leave their money in the market to regain their losses.  So, you have to be aware that nothing is certain.

529’s can be used for undergraduate or graduate studies at any accredited two-or-four-year college or vocational school anywhere in the U.S.  If your child decides not to go to college, because you are the owner of the money, you can move the beneficiary for another child to be the recipient.

The other interesting feature of 529’s is that the proceeds can be used for tuition, books, fees, supplies, and room and board.  You control the account; your child will not have access to it, and anyone can contribute to the account.  I like 529’s because they offer the most flexibility.

Prepaid Tuition Plans:

If you are certain that your child is going to attend an in-state public school, you may want to consider a prepaid tuition plan. Not all states offer these plans. Check to see if your state offers a plan, and if available, it will allow you to pay for tuition credits at a predetermined price.  Prepaid Tuition Plans offer the same tax advantages as 529’s.  Depending on your state’s regulations, you may also get a state tax deduction as well.  As noted above, 529 plans will fluctuate with the stock market; however, with prepaid plans, in many cases, states will assume the market risk for the investor. In theory, they are guaranteed by the state, but read the fine print; you might find that the language may say that if the state, and consequently, the plan, are faced with a budgetary shortfall, investors could be in trouble.

What’s the catch? If your child decides to go another out-of-state school, you may get a reimbursement; however, it is probable that you will not get the full value of your plan returned.  It is also challenging for the states to keep up with the growing costs of college. The plan’s investments could be growing at a slower rate than the costs of college. You can, as with 529’s, change beneficiaries, but the money can only be used for tuition. Funds used for other expenses will incur a 10 percent penalty.

UGMA or UTMA:

Uniform Gift To Minors Act (UGMA) or Uniform Transfer To Minors Act (UTMA) accounts allow parents to set up an account in your name with your minor child as the beneficiary.  The government rules enable you to make a financial gift to a minor (who will benefit eventually from the use of the money) and name someone as the custodian of that account.  The first $1,000 (approximately) in gains is tax-free; the second $1,000 is taxed at the child’s income tax rate (which is presumed to be lower than yours).  The good news is that, when your young adult reaches the age of majority (18 or 21, depending upon your state), your child can use the money for any purpose.  The bad news is that your child can use the money for any purpose.  If you have intended the money to go towards their college education and they think that a Ferrari is what they want, it is tough to prevent that. Unlike the other college savings accounts above, you will not have the ability to transfer the account to another child or change beneficiaries when your child is eligible to receive the money.

The other bad news is that, if your child is considering applying for Federal Financial Aid, a custodial account is regarded an asset for your child and will be counted against them when they fill out their asset statement for the financial aid application.

The most important thing to remember is to start saving early and on a regular basis.  Involve your child in the process and in saving for their future.