Top 5 Investments to Build Your Child’s College Fund

February 14, 2022

If you have children, you know how important it is to ensure they will be successful in the future. One of the most important factors for future success is to make sure your child gets a solid education at a good college or university.

However, the costs of attending college are increasing steadily. Unless you act now to begin building a college fund for your child, you may not be able to afford the best school for them. Here are the top five investments for building your child’s college fund.

1. A 529 College Savings Investment Account

As one of the most popular ways to invest in your child’s future, a 529 plan offers many benefits. Named after IRS Section 529, a 529 plan is an investment account that offers tax-free benefits when used to save money for tuition expenses for either college, K-12, apprenticeship programs, and even repayments to existing student loans.

There are hundreds of 529 plans from which to choose, as nearly every state in the Union offers at least one. Each of these plans have associated investment portfolios. When you make regular contributions to a 529 plan (limited to a maximum of $16,000 per year in 2022 if you want to avoid paying tax on these funds), payments are invested in these portfolios.

529 plans are also advantageous in that they have little impact on a student’s ability to receive financial aid. As long as a 529 plan is in your name, or in the name of your child, then the assets held in a 529 are weighted more favorably (at only around 5 percent) than assets not held in a 529 (typically around 20 percent). However, this does not apply to 529 plans owned by grandparents or other third parties.

2. A Roth IRA

While usually considered vehicles for retirement income, a Roth IRA is yet another way to invest in your child’s future education. Like a 529 plan, Roth IRAs offer tax-free savings; the plan allows tax-free qualified withdrawals.

However, unlike 529 plans, Roth IRAs are funded by after-tax dollars. Additionally, the amount you can contribute to a Roth IRA is different from that of a 529 plan. For 2022, annual contributions are limited to $6000 (or $7000 if over the age of 50). Also, if you make more than $140,000 a year (or $214,000 if married), you are ineligible for Roth IRAs completely.

Roth IRAs are also limited in that only you can make contributions to it, not a third party such as a grandparent or other relative. On the upside, if your child chooses not to attend college, you can continue to build your Roth IRA funds to use for your own retirement in the future.

3. Mutual Funds

Unlike Roth IRAs and 529 plans, there are no limits on how much you can invest in mutual funds. This makes mutual fund investing a versatile choice for anyone who wants to ensure their child has the resources necessary to afford attending college.

That being said, there are a few disadvantages to investing in mutual funds. Anything you earn from a mutual fund will be subject to annual income taxes. Likewise, selling shares to access those funds will mean you will need to pay capital gains taxes. These funds may also reduce financial aid eligibility for your child.

At the same time, mutual funds don’t have to be used for college, much in the way Roth IRA savings don’t have to be either. This makes mutual fund investing much more versatile, even if the tradeoff is having to deal with tax liabilities.

4. Savings Bonds

If you’re looking for an investment that is exceedingly low risk, then purchasing savings bonds from the US government is one of the best ways to avoid investment risk. These bonds take several decades to mature, but can then be cashed in to help pay for tuition costs associated with attending college.

Thanks to the Education Savings Bonds Program, eligible bonds used in this way allows qualified taxpayers an exemption on paying taxes on all or a portion of interest earned upon redeeming these bonds. This can be advantageous when it comes to financial aid, as this interest isn’t counted as parental income.

If there is one disadvantage associated with investing in savings bonds, it’s that the interest rate is exceedingly low at just 0.10 percent. However, the US Treasury guarantees that bonds purchased in 2022 and kept for 20 years before cashing them in will be worth twice what you paid for them.

5. A Coverdell Education Savings Account

Known as the Education IRA until 2002, the Coverdell Education Savings Account is similar in form and function to a 529 plan. However, there are some important differences that may make a Coverdell ESA more advantageous in some situations.

A Coverdell ESA allows you to self-direct your investments, which is something unavailable to 529 investors. There are fewer withdrawal limitations with a Coverdell ESA as well, as you can use these funds for not just tuition expenses at qualified elementary and secondary schools but also books, supplies, equipment, academic tutoring and special needs services.

However, Coverdell ESAs have a much lower contribution limit than a 529 plan. Annual limits are $2000 per child. Income limits are also lower than 529 plans, making a Coverdell ESA only a good choice for individuals or families with fewer resources available to them.

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