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Baby step 5 comes after taking care of the priorities of emergency funds, paying off consumer debt and saving 15% in your retirement savings. At this point you can move into saving up to help pay for your child’s education. However, we stress make your retirement savings the highest priority over saving for education. Do not allow ‘parental guilt’ keep you from a safe and secure retirement.
Here are some ways that you can save for your kid’s college education.
- Education Savings Account (ESA): You may save $2,000 (after tax) per year, per child that grows tax free! Beneficiary must be under 18 years old. Money must be used for education purposes only. Otherwise, a 10% penalty and taxes will apply. Money must be used or rolled over to a qualifying family member by age 30 or a 10% penalty and taxes will apply. Singles with an income over $110,000 – or married couples with an income over $220,000 are not eligible.
- 529 Plan: If you do not meet the income limits for an ESA, or if you want to save money above an ESA, you can use a certain kind of 529 plan. You can save up to $12,000 per year, per child in a 529 plan. The money must be used for higher education only. Otherwise, a 10% penalty and taxes will apply to the gains only.
- UTMA/UGMA Plans: UTMA (or UGMA) stands for Uniform Transfer (Gift) to Minors Act. Not usually as good as the ESA or 529 plans.
Do not use the following items as a way to pay for college education :
- Insurance
- Savings bonds (only 5-6% growth)
- Zero-coupon bonds. (only 6-8% growth)
- Pre-paid college tuition (only 7% inflation rate)
- 401k loan (never!)
- Home equity loan
ESAs, 529 Plans and UTMA/UGMA plans are the preferred methods for saving.
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