How to Start a College Fund for Your Child

Pursuing higher education is expensive, and the price tag has only continued to climb. The student debt load in the U.S. hovers at $1.5 trillion and makes up the largest chunk of household debt in America, second only to mortgages. Currently, there are nearly 43 million Americans shouldering federal student loans. 

Saving for your child’s education can help set them on solid financial footing, by ensuring they’ll carry as little student debt as possible. Learning how to start a college fund for your kids is an excellent first step.

When should you start saving for college?

Because of the high and rising costs of saving for college, it's important to start saving early for a college fund. It might sound like a tall order, especially when faced with all of life’s other expenses. When juggling different financial priorities and goals, you might be tempted to push your intentions of saving for college aside. But waiting too long could mean not reaching your savings goals for your child's higher education.

It certainly couldn't hurt to start a college fund for your child as early as possible. You don't need to wait for that "perfect moment" when you're raking in X amount of income or when you get a windfall of cash.

Here’s what an additional year or two could do to help boost that college fund for your child. If you set aside $20 a week, in a year's time that's $1,040 before interest. Bump that weekly savings amount to $40, fast forward a year, and you'll have $2,080 set aside for college. The more you’ve saved up for your child's college fund, the less you'll need to lean on crippling student debt or seek other sources of financial aid, which can be time-consuming and competitive.

Choosing a college savings fund

There's no one best college fund for a child, nor is there a tactic that works for everyone. What does work is to know what options exist, and to find the best course of action for you. Here are some college-saving options you can use to kickstart a college fund.

529 plans

Also known as a qualified tuition program, a 529 plan is a savings account for your child's education. There are two types of 529 plans: prepaid plans, which allow you to pay ahead of time for eligible college expenses at a particular in-state institution; or savings plans, where you can put away money for any institution.

There are a few tax advantages to a 529 plan: The money grows tax-free, and the money you take out and use for eligible education expenses is also tax-free. You can use up to $10,000 of funds from a 529 plan for expenses at a private elementary or high school per year.

Should there be money left over and your child has student loans, you can use money from a 529 plan to pay for your child or their sibling's student loans, up to $10,000.

Wondering how to start a 529 plan? There are a number of 529 plans available, so start by researching the ones that appeal to you. 529 plans are usually run by states, so you can do a search in your state to see what plans are administered there. You can contribute to an in-state or out-of-state plan, so you don't have to go with a 529 that's only for your state. Depending on the plan, it could cost as little as $10 to open a 529 plan.

Coverdell Education Savings Accounts

With a Coverdell education savings account, you can sock away as much as $2,000 per calendar year toward your child's school expenses. Like a 529 plan, funds from a Coverdell fund can also be used for kindergarten through grade 12.

You'll need to set up a Coverdell ESA before your child turns 18, and the money you take out must be used for qualified education expenses. A major perk of a Coverdell ESA is that distributions are tax-free (so long as they don’t exceed the amount of the beneficiary’s qualified education expenses).

UGMA accounts

Short for Uniform Gifts to Minors Act, a UGMA is a type of custodial account that allows you to transfer assets to your child. While not specifically a savings account designed for college, your child can tap into those funds for anything they like, including paying for college. Students might be able to put the money toward expenses not covered by a 529 plan or Coverdell ESA.

Although money you put into an UGMA account isn't tax-sheltered, because contributions are considered a type of gift, there are some tax breaks. There is no limit to how much you can put in, and you can deduct up to $15,000 as an individual in 2021 under the gift tax. If you are married, you can contribute as much as $30,000.

Another tax perk: The funds your child receives from a UGMA account fall under unearned income, so if that unearned income is less than $2,200, they won’t be subject to income tax. If their unearned income is more than $2,200, they may need to pay the so-called kiddie tax.

Individual retirement accounts (IRAs)

It's true that an IRA is designed primarily to save for retirement. However, you can use some of your funds before you reach age 59 ½ to help pay for your child's education. Note that 59 ½ is the minimum age you can take out money, no matter what the amount, without getting dinged with the 10% early withdrawal penalty.

There are some criteria you'll need to meet to avoid getting hit with the 10% penalty. The money you take out for your child's college must be used for qualified expenses—tuition, fees, books, and other school supplies. If your child is enrolled at least part-time, then room and board are qualified expenses.

There are two types of IRAs: traditional and Roth. Although the contribution limits are the same—$6,000 for 2021, and $7,000 if you're 50 or older—the major difference is when you'll be taxed. With a traditional IRA, you'll be taxed when you take the money out. With a Roth IRA, you'll be taxed the year you make contributions. In other words, money you put into a traditional IRA is pretax dollars, and money you put into a Roth IRA is with after-tax dollars.

Although you don't have to pay an early withdrawal penalty, you do owe any federal taxes on your withdrawals. This only applies to a traditional IRA, which has pretax contributions. If you have a Roth IRA, contributions you made were with after-tax money, so you don't owe any federal taxes.

If you decide to take out money from your IRA, it's important to know that while it is an option, and you can do so fee-free, that's less money you'll have for your own retirement.

Personal savings

You can also open a separate savings account just for your child's college fund. The benefit of doing this is that, while there aren't any tax perks, you can contribute as little or as much as you want, and the money can be used toward any expenses.

How much money do you need to start a college fund?

There's no magic number for how much you'll need to save, nor do you need a ton of money to start a college fund. According to the Sallie Mae report, “How America Pays for College 2021,” families spent an average of $26,373 for the 2020-2021 school year.

The cost of going to college can vary depending on the school, whether it's in-state or out-of-state, and if it's a private or public institution. According to data from the College Board, the average cost of tuition and fees for a four-year public, in-state university in 2020-2021 was $10,560. The average cost for a four-year public, out-of-state university was $27,020. A private, four-year university cost an average of $37,650.

These averages are just for a single academic year and don’t include supplies, books, equipment, room and board, and other living expenses. So you'll need to factor in those costs when saving for college.

You can get started saving for a college fund for as little as a few dollars. Drum up a plan, a timeline, and the amount you ideally want to save for your kids' higher education. You can use a handy college fund calculator to figure out how much you need to save each year to meet your goal.

So how can you start a college fund for someone else? Accounts designated for higher education expenses can be opened in your name, and your child can be designated as the beneficiary. In turn, your child can take out money, or distributions, to use for college. These types of accounts can be opened at any brokerage or financial institution that offers them.

The bottom line

Starting a college fund for kids is important, and ideally you'll want to kickstart one as soon as you can. By researching your options and estimating how much you'll need to save, you’ll have a better shot of reaching your goals.