We do our best to ensure the health, happiness, safety, and security of our children. We try to provide them with the resources and opportunities they need to lead happy and successful lives when they grow up. In order to do that, every parent needs to know the best way to save for college, which can be very expensive.  The best approach is to start as early as you can because the power of compounding over time is very powerful. Albert Einstein described compound interest as the eight wonder of the world.

Reduce financial worry and ensure your ability to afford the cost of a degree by saving regularly for your child’s future. 

Set up a 529 plan. One of the best ways to save for college for your child, these state sponsored higher education savings accounts grow tax-free if you follow the rules. Each state determines the maximum contributions, eligible investments, and tax advantages of its 529 plan. Although you will not get a tax deduction, the funds grow tax-deferred, and distributions will be tax-free if used for qualified education expenses of the beneficiary of the 529 plan. Qualified expenses include items such as tuition, fees, textbooks, supplies and equipment required for enrollment, and special needs services. If the student is attending at least halftime and payments are made directly to the college, they will also include room and board costs. Supplies may also include a laptop, printer, computer, and internet service.

Avoid the 10% penalty. Non-qualified withdrawals of income from a 529 will be subject to ordinary income tax as well as a 10% penalty to the individual who receives the money, which can be either the owner or the beneficiary of the account. The principal portion of the withdrawal, or the contributions made to the 529 plan, will not be subject to tax. Make sure that the withdrawals are used only for qualified expenses to avoid taxes and penalty.

There are exceptions to the 10% penalty. If a withdrawal is made from a 529 plan because the beneficiary dies, becomes disabled, or has earned scholarships and doesn’t need the money, the 10% penalty will be waived. Income taxes will still apply to the income portion of the withdrawal.

If a child does not go to college or receives a scholarship, the owner may change the beneficiary to a sibling of the child or another member of the child’s family. This flexibility is very beneficial in making a 529 pan an attractive investment for the long term.

Choose the most advantageous investment options.  A variety of mutual funds will be offered as investment choices. Aged-based funds are used quite often, as they have a more heavy weighting in stocks with a young child and are frequently rebalanced to have a more heavy weighting in bonds the closer the child approaches college age. To open a 529 plan, you may either make a lump sum investment and then contribute to it periodically or set up a monthly bank draft, a great way to save for your child’s education.

Make monthly or periodic contributions. There are no income restrictions to making a contribution to a 529 plan. Although there is no annual maximum limit, contributions per year over $15,000 per individual to a 529 plan are subject to federal gift tax rules.  Each state has a specific maximum contribution amount, which generally varies between $235,000 and $500,000. You do not have to contribute to your state’s 529 plan but should consider state tax advantages when making a decision about which 529 plan to use. Distributions may be used for schools out of state.

  • Accelerated gifting of 5 years of contributions is allowed to a 529 plan, a total of $75,000 per individual or $150,000 for a married couple filing jointly, without having to file a gift tax return. An important tax benefit, the value of the account and its tax-free growth are excluded from the contributor’s estate for federal estate tax purposes. To avoid having to file a gift tax return, do not make additional contributions for 5 years if the entire accelerated gifting has already been completed.
  • The contributor will normally be the account owner, but not necessarily. For example, a grandparent may fund a 529 plan with their child as the owner and a grandchild as beneficiary. The owner of the account has the right to name a successor co-owner and the beneficiary, choose the investments, and decide when and how much to distribute.
  • Parents, grandparents, other relatives, and friends who are U.S. citizens or resident aliens and at least 18 years old may open a 529 plan and make contributions. They may also make contributions to 529 plans that are owned by others. A great idea is to ask relatives to make a contribution to a 529 plan in lieu of gifts that will eventually be discarded by your child.

529 plans impact financial aid. 529 plans owned by college students or their parents currently reduce need-based aid by a maximum of 5.64% of their current market value. This calculation also includes the parent’ savings, checking and brokerage accounts, and real estate except for the primary residence. Withdrawals made from a 529 plan held by a non-custodial parent will be treated instead as income against financial aid, just like those held by grandparents.

Importantly, make sure the 529 plan is tailored to your family’s needs and goals for the future. To find the right college savings plan for your specific situation, ask your financial advisor to compare 529 plans for you and explain the details, including costs and risks. Prepare a budget to determine a realistic amount that you can set aside regularly for this long-term goal as well as an account for your own retirement. Your retirement is also a priority, as well as your child’s education. Look at the whole picture when making decisions about how to allocate resources.

Rosemary Lombardy is a financial advisor with over 35 years of experience, and the founder of Breaking Bonds, a comprehensive resource for abused women. Although her professional expertise is in financial matters, her perspective on marital abuse, divorce, and recovery is deeply heartfelt and holistic. She draws on decades of personal experience, as well as the experiences of others, to help inform abused women so that they will become empowered to leave their abusers and begin to heal. Her new book, Breaking Bonds: How to Divorce an Abuser and Heal – A Survival Guide is available on Amazon, Barnes & Noble, and anywhere that sells books.