It’s never too early to start college financial planning. The college search and application process may wait until later in high school, but saving money for college should start much earlier — even when children are infants, experts say.
“That might not be a ton of money early on, but doing a little bit over a long period of time, you have the power of compounding interest working in your favor,” says Shannon Vasconcelos, senior director of college finance at Bright Horizons College Coach, a college admissions consulting firm. “Starting to think about it as early as possible and saving is a great move.”
Families spent an average of $28,026 on college expenses in 2022, according to a national study by Sallie Mae and Ipsos. Family income and savings covered half of those expenses, and scholarships and grants covered 29% of the costs.
Parents can use various methods to save and plan for a child’s college education. As college costs continue to rise, here are five strategies that experts recommend.
Open a 529 College Savings Plan
A 529 college savings plan is an investment savings account intended to be used for qualified education expenses, such as tuition and fees, housing and food. Anyone can contribute to the fund, and the money grows over time through interest.
Money can be withdrawn tax-free any time as long as it’s used for education expenses. If the money is not used for qualified expenses, income taxes and a 10% penalty on the earnings will apply.
There’s no age requirement for the beneficiary of a 529 plan, so parents can open it when they see fit. People who are not yet parents but plan to have children can open a 529 plan in their own name and eventually make the child the beneficiary.
[READ: How Having Multiple Children in College Affects Financial Aid.]
“529 plans are definitely the best way to save for college, as long as the parents start when the kid is young,” says Julie Gross, owner of College Financial Consultants, a New Jersey-based financial aid consulting agency. “As far as starting when the kids are a little bit older, it’s probably best just to save as part of their own assets in their own brokerage or high-yield savings accounts.”
The plans are transferable, so whatever the designated child doesn’t use can be kept in the account and used for qualifying higher ed expenses of siblings, grandchildren or other qualifying relatives.
“For your grandkids, that’s 30 years of tax-deferred growth,” says Joseph Messinger, co-founder and director of college planning at Capstone Wealth Partners, an Ohio-based financial planning company. “Let’s say your kid have kids 20 or 30 years from now. That’s a really nice nest egg for your grandkids’ college if you have money left over.”
Open an Individual Retirement Account
Parents may also want to invest in an individual retirement account. However, there are rules for using an IRA account to pay for college or graduate school that families should know before withdrawing money.
IRA funds can be used for qualified education expenses, similar to 529 plans, without penalty as long as the expenses are for one’s self, a spouse, child or grandchild.
Students must be enrolled at least half time in a qualifying institution, which generally includes any accredited public, nonprofit or private, for-profit college, university, vocational school or other postsecondary educational institution, according to the IRS. The school must also be eligible to participate in the federal student loan program.
Another IRA option is the Roth IRA, which is funded by post-tax dollars instead of pretax dollars in a traditional IRA. Though both types of IRAs can be used to pay for educational expenses without the penalty for early withdrawals, those who take early distributions from a traditional IRA will still have to pay income taxes on those amounts.
[Related:How to Pay for College Without Loans]
Experts caution parents about using IRAs, a 401(k) or other retirement savings to fund their child’s college education. If they use retirement savings, it’s important to be strategic about when the money is withdrawn, Gross says.
The Free Application for Federal Student Aid, or FAFSA, uses a family’s federal tax return information from two years prior. That’s the base year that determines a student’s financial aid eligibility.
“It’s very important to understand that for that prior prior year, that base year, that the family should not do anything that’s going to create large capital gains,” Gross says. “Don’t borrow money from 401(k)s or IRAs or take money out of those retirement funds because those funds do get tacked onto a family’s adjusted gross income, which can inflate their income.”
Coverdell Education Savings Account
Another savings option for parents, similar in some ways to a 529 plan, is a Coverdell Education Savings Account, known as an ESA. It’s a tax-advantaged account designed to help families save for elementary, secondary and college expenses. There are some specific requirements for this plan as well, according to the Internal Revenue Service.
For example, the account must be earmarked as a Coverdell ESA when it’s created and beneficiaries must be under the age of 18 or a special needs beneficiary. There’s no limit to the number of accounts that can be established for a particular beneficiary, but the total contribution to all accounts on behalf of a beneficiary in any year can’t exceed $2,000. Contributions must be made in cash and they’re not tax-deductible.
Many people don’t qualify for the Coverdell ESA because of income restrictions, but it’s another way to save, Messinger says. “You can’t put in nearly as much, but it does open you up. You can really invest into anything you want in Coverdell, and it has most of the same tax benefits.”
Ask Family and Friends to Help
In many cases, immediate and extended family and friends are willing to contribute to a child’s education fund. While it may not be exciting for some children and teenagers, contributions to college savings accounts are good gifts, experts say.
Cash gifts that can be placed in traditional savings accounts work well, too.
“College is expensive and it takes a village to come up with the funding for college,” Vasconcelos says.
[Read: How to Pay for College Using These Overlooked Strategies.]
If family members or friends promise to help contribute, it’s important to iron out exactly what they plan to contribute. This helps parents plan accordingly, Messinger says.
“It’s so taboo,” he says. “But it’s like, ‘Hey, grandpa and grandma, are you going to be able to help with $5,000, or $5,000 a year?’ Because those are very different numbers.”
Scholarships, Grants and Federal Student Loans
Students won’t start applying for scholarships or financial aid until around their senior year. Well before that, parents should help them research potential scholarships and which colleges give the most need-based aid, experts say. Students can earn scholarships in various areas, such as athletic ability, strong grades or hobbies.
Financial management company SoFi estimates $100 million in scholarship money goes unclaimed each year, money that can be won with proper planning and execution, experts say.
Many schools offer grants for students whose families have income below certain levels, and some top schools meet full financial need of all students eligible for federal loans.
“So focus on where you can shop smart and where you can get your discounts based on your family,” Messinger says.
If federal loans are the chosen route, families should talk to determine which portion parents plan to cover and which will be the child’s responsibility to pay back. If that involves the student working and saving money, those conversations should happen early, Vasconcelos says.
Parents and students should also set clear expectations early for what they hope to get out of college and what they can afford. Those discussions should begin when a child enters high school, she says.
“Really difficult conversations happen in April of a child’s senior year when they’ve gotten into the college of their dreams and now you have to tell them you can’t afford it,” she says. “Make the conversations easier by having them earlier.”
Trying to fund your education? Get tips and more in the U.S. NewsPaying for College center.
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5 Ways Parents Can Do College Financial Planning originally appeared on usnews.com
