How to save for college with confidence

What does it mean to save for college?

Saving for college means setting money aside, often over many years, to help pay for a child’s education after high school. Knowing how to save for college comes down to three choices: how much to aim for, which account to use, and how to fit those savings alongside your other goals. The education might be a university, a community college, a trade school or an apprenticeship.

A college fund does not need to cover every dollar. Most families combine savings, current income, scholarships, grants and, sometimes, student loans. Every dollar saved is a dollar your child may not need to borrow.

How much does college cost?

Colleges publish a cost of attendance that covers tuition and fees, housing and food, books and supplies, and transportation and personal costs. This published sticker price is rarely what families pay. The figure that matters more is the net price: the cost after grants and scholarships. Colleges that take part in federal aid programs must offer a net price calculator on their websites, which gives a personal estimate based on your income and assets. Public in-state schools generally cost far less than private colleges, and community college can lower the cost of the first two years.

How much should you save for college?

A widely used guideline is the one-third approach: save about a third of expected costs, pay about a third from income during the college years, and cover the rest with aid, scholarships and modest borrowing. It is a rule of thumb, not a requirement.

The earlier you start, the less you need each month. The table below shows hypothetical monthly savings needed to reach different goals, assuming a steady 5 percent yearly return. Real returns vary, and investments can lose value.

What is a 529 plan and how does it work?

A 529 plan is a tax-advantaged account designed for education savings, named after the section of the tax code that created it. Plans are sponsored by states, but you can usually open one in any state. Money you contribute is invested, and any growth is free from federal income tax as long as withdrawals pay for qualified education expenses.

The account owner, usually a parent or grandparent, keeps control of the money, and the child is the beneficiary. There are no federal income limits on contributors, and each plan sets its own high maximum balance.

Education savings plans vs. prepaid tuition plans

Most 529 accounts are education savings plans, with a menu of investments that often includes age-based portfolios that grow more conservative as college nears. A few states offer prepaid tuition plans, which lock in tuition at participating schools at today’s prices but are less flexible.

State tax benefits vary by state

Many states offer an income tax deduction or credit for 529 contributions, but the rules differ widely. Some reward only contributions to the home-state plan, a few reward any state’s plan, and others offer nothing, including states with no income tax. Some also take back past deductions if money is later used for non-qualified purposes. Check your state’s rules first, because a home-state benefit can tip the balance.

What counts as a qualified expense?

Qualified higher education expenses generally include tuition, fees, books, supplies, required equipment, computers and, for students enrolled at least half time, housing and food. Federal rules also allow 529 money to be used for some K-12 tuition up to a yearly limit, for registered apprenticeship costs, and for a limited amount of student loan repayment. Not every state follows these newer federal rules, so confirm your state’s treatment.

What if your child does not go to college?

You can change the beneficiary to another family member, such as a sibling, or keep the account for later study. Federal law also allows a limited rollover from a long-held 529 into a Roth IRA for the beneficiary, subject to a lifetime cap and other conditions. For other non-qualified withdrawals, the earnings portion is subject to income tax plus an additional 10 percent federal tax.

What is a Coverdell education savings account?

A Coverdell education savings account, or ESA, also offers tax-free growth for qualified education expenses, including a broader range of K-12 costs, and lets you pick your own investments. The trade-offs are significant. Contributions are capped at a small yearly amount per child, eligibility to contribute phases out at higher incomes, and the money generally must be used by age 30 unless the beneficiary has special needs. Many families use a Coverdell, if at all, alongside a 529.

Are custodial accounts a good way to save for college?

Custodial accounts, set up under your state’s Uniform Gifts to Minors Act or Uniform Transfers to Minors Act, hold money that legally belongs to the child. An adult manages the account until the age set by state law, often 18 or 21, when the young adult gains full control and can spend it on anything. These accounts offer no education tax break, a child’s investment income above a certain amount may be taxed at the parents’ rate under the kiddie tax, and they count more heavily against financial aid.

Can a Roth IRA be used for college?

A Roth IRA is a retirement account, but it can act as a flexible backup for college costs. You can withdraw your own contributions at any time without tax or penalty. Earnings withdrawn early for qualified higher education expenses avoid the usual 10 percent penalty, though they may still be subject to income tax.

If your child does not need the money, it simply stays put for your retirement. The downside is that every dollar used for college stops growing for your own future. You need earned income to contribute, income limits apply, and withdrawals can count as income on a later aid application.

How do college savings options compare?

Some limits change over time, so check IRS.gov and your plan’s documents for current figures.

How to save for college, step by step

1. Steady your own finances. Build an emergency fund and keep saving for retirement, at least enough to get any employer match.
2. Estimate the cost. Use net price calculators for a few likely schools.
3. Pick a target. Decide what share of costs to cover from savings.
4. Compare 529 plans. Check your home state’s plan for tax benefits, then compare fees and investments.
5. Automate contributions. Set up a monthly transfer and raise it when your income grows.
6. Review once a year. Check progress and shift to a more conservative mix as college nears.

Our budgeting and saving guide can help you find room in your monthly budget for these contributions.

Compare 529 plans and other options

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How does financial aid work?

Financial aid comes from the federal government, states, colleges and private groups. The main types are:

• Grants, which generally do not need to be repaid and are often based on financial need.
• Scholarships, awarded for merit, talent, background or need.
• Work-study, which provides part-time jobs for students with financial need.
• Federal student loans, which must be repaid with interest.

The key to most aid is the Free Application for Federal Student Aid, or FAFSA, completed online at StudentAid.gov. It usually becomes available in the fall before each school year, and you file a new one every year. It produces a Student Aid Index, which colleges use to set need-based aid. Some private colleges also require the CSS Profile, which looks at finances in more detail.

How do college savings affect financial aid?

Many parents worry that saving will reduce aid. In general terms, the effect is smaller than people expect. The federal formula counts only a small portion of parental assets, while savings in the student’s name count at a noticeably higher rate.

• A 529 plan owned by a parent, or by a dependent student, is generally reported as a parent asset, which has a modest effect.
• Custodial accounts are reported as student assets, which can reduce aid eligibility more.
• Retirement accounts, including 401(k)s and IRAs, are not reported as assets on the FAFSA.
• The value of the family home is not counted on the FAFSA, though some colleges that use the CSS Profile may consider it.
• Under recent changes to the FAFSA, money from a 529 owned by a grandparent is no longer reported as student income.

For most families, the benefit of savings far outweighs any small reduction in aid.

Should you save for college or retirement first?

For most families, retirement comes first. Students have many ways to pay for college, including scholarships, grants, work and loans, but there are no scholarships for retirement. Falling short later could mean relying on your children.

A balanced approach often works well: save enough for retirement to capture any match and stay on track, then direct extra savings to a 529 plan. Our retirement planning guide explains how to check whether you are on track, and our investing basics guide covers how to choose a sensible investment mix.

Common college savings mistakes to avoid

• Waiting until high school to start, which leaves little time for growth.
• Pausing retirement contributions to fund college, and losing an employer match.
• Choosing a 529 plan without checking your state’s tax benefits.
• Keeping an aggressive investment mix right before tuition bills arrive.
• Putting large savings in the child’s name without weighing the effect on aid.
• Skipping the FAFSA because you assume you earn too much to qualify for anything.

When should you talk to a financial advisor?

Many families can open a 529 plan on their own. A financial advisor can help when trade-offs get harder: balancing college with retirement, saving for several children, coordinating gifts from grandparents, or deciding how to draw down accounts once tuition bills begin. An advisor can look at your full picture, including taxes and investments, and help you build a plan that fits your family.

Frequently asked questions