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It's no secret that college costs are escalating, which means that student debt is increasing. In fact, as the Brookings Institution shares, it is the second biggest segment of household debt after mortgages, superseding even credit card debt.
While many families are able to start saving for eventual education expenses when they have time on their side for the funds to grow, adult learners may be needing the money sooner rather than later. One size doesn't fit all when it comes to investment options. Here are three popular types of college savings plans and what students should know about each.
For the Adult Learner Ready to Begin Their College Journey
The Certificate of Deposit (CD)
For adult learners who are planning to pursue their degree sooner rather than later, a CD might be a good savings choice. With this investment product, you will invest a lump sum payment with a bank or credit union, which pays a fixed interest rate for a designated period of time. At that point, you will get your original investment back, supplemented by the stated interest rate.
A CD may offer a more steady option than other savings vehicles for two reasons: You are assured of getting your entire initial investment back, and the amount you will eventually end up with (interest included) won't fluctuate based on market ups and downs. So while the relative return rate might be lower than an investment tied to a surging stock market, the peace of mind of a guaranteed return can be worthwhile, especially if you are intending to use the investment in the near future as you pursue your degree.
CDs are extremely flexible and available for a wide range of terms from three months to 18 months or more. One strategy that may work for you is to buy CDs with different "maturity" dates that allow your investment to pay off at various times, perhaps to coincide with tuition due dates. That also can be a smart strategy if interest rates grow; you can take advantage of a rising interest rate by making another investment, rather than having your money locked up in a designated interest rate that might be lower.
One strategy that may work for you is to buy CDs with different "maturity" dates that allow your investment to pay off at various times, perhaps to coincide with tuition due dates.
For the Student Attending College in a Few Years
The 529 Plan
529 college savings plans, which are named for the section of the Internal Revenue Code that created them, allow college savings to grow tax-deferred, which means the gains accumulate tax-free. And, in a double tax bonus, you don't have to pay federal income taxes on the money when you withdraw it, as long as you use the funds for "qualified college costs." These have a far-ranging definition and include tuition, fees, books and materials and even associated technology, among other approved expenses, when used at any accredited college – including most online programs. If the money is used for any other reason, you will pay a 10% tax penalty.
Anyone can open a 529 plan as there are no age or income limits. It also means that if you plan to attend a school in several years, you can start saving today, although you will gain the most from the tax advantages – and the fund's growth – if you're saving over a longer period of time.
One element of opening a 529 savings plan that can be confusing is deciding which state's plan to sign up for. Each state administers its own plan, but that doesn't mean you are limited to the state where you live, or that just because you buy a certain state's plan, that you are locked into attending a school based there. You can use your 529 to pay tuition at any accredited school, including online institutions.
The various plans have different cost structures and investment options so you'll want to research them to find the one that fits your needs. In some states' plans, there may be additional tax benefits for residents so make sure to check if that is the case; often those state tax advantages can make it a clear winner.
When you open the plan, you designate a "beneficiary," which can be you if you're planning to earn a degree. If your situation or goals change, you can switch the beneficiary to another family member, including a spouse, as often as once a year without losing the tax advantages.
In some states' plans, there may be additional tax benefits for residents so make sure to check if that is the case; often those state tax advantages can make it a clear winner.
For the Parent Saving for Their Child
Coverdell Education Savings Accounts (ESAs)
ESAs – which used to be called Education IRAs – are another popular college savings vehicle that offer the same tax advantages as 529 plans in that you enjoy tax-deferred savings and tax-free withdrawals. But they differ in one key way: You can only contribute up to $2,000 per account per year. And, if the funds are not fully withdrawn by the time the beneficiary reaches the age of 30 (unless the beneficiary qualifies as special needs), the money will be subject to taxes and penalties. Therefore investing in an ESA can be a wise strategy to consider as you plan your family finances holistically, but not as useful for someone who is trying to save as an adult for an eventual return to school.
Save Early, Save Often
Given the various college savings plans that offer different advantages and limits, there is an option for everyone. In fact, the most important thing to do is to make sure you start saving as soon as you can. Then, conduct thorough research to ensure you choose the best college and program for your financial situation and career aspirations. The more planning you do, the less you will struggle with overwhelming student loan debt, and the more satisfied you will be with the eventual outcome of your college journey.
Note that this material has been created for informational purposes only and is not designed to provide tax or accounting advice. Always talk to a tax, legal or accounting advisor before engaging in a transaction.