When a new baby comes into the world, friends and family are excited to celebrate their birth and start dreaming of their future.
Many loved ones find themselves wondering how they’ll help fund that future, especially when it comes to a college education.
While it might seem like a baby’s first months are too early to begin thinking about saving for college, there’s actually no better time.
Starting early gives your money plenty of time to grow, and it can help ease the emotional and financial burden that loved ones often feel when trying to come up with the funds later in life.
Are you saving for college for a new baby in your life?
In this article, you’ll learn everything you need to know about the importance of starting a baby’s college fund and how to start saving.
Starting a College Fund For a Baby
In a perfect world, all families would be able to cover the costs of their children’s college education without stress. Unfortunately, that’s rarely the case.
While funding a baby’s education down the road is more doable than you might think, it comes with plenty of questions, including when to start saving and how much to save.
When to start saving
Childhood goes by more quickly than most of us would like, and it’s possible for years to pass before college savings becomes a priority.
But the truth is that when saving for a child’s college education, the earlier, the better. In fact, the best time to start saving is as soon as a new baby enters the world.
To show just how important starting early is, consider an example of a family who decides to save $200 per month for a child’s education. For this example, let’s say you’re saving in an investment account with an annual return of 8%.
First, imagine the family began saving when the child was 10 years old.
During the eight years before the child heads off to college, the family would save $19,200. And with investment returns, the savings would have grown to more than $25,000.
But what if that same family had started saving when the child was born?
By saving for an additional ten years, the family would contribute more than $43,000. And with investment returns, that child’s college fund would grow to more than $90,000.
There are other benefits to starting early as well.
For example, imagine that you begin saving when the baby is born, but later, you lose your job and can no longer save. The money you’ve already set aside will continue to grow, and you’ll still be able to help fund that child’s college education.
But if you’d planned to start saving later, you might have never saved a dime.
How much to save
The other question you may find yourself struggling with is how much you should save.
The cost of higher education has grown dramatically in recent years. Who knows how expensive it’ll be 18 years from now when your new baby is ready to head off to college?
According to EducationData.org, the average cost of attending a four-year public university in 2021 is $25,864 per year. That means your total cost for a four-year education is more than $100,000.
Of course, the cost could be more or less depending on the type of school you’re looking at.
For example, a two-year public school costs around $16,000. On the other hand, a four-year private college can cost nearly $54,000 per year.
So how can families actually use this information to decide how much to save?
Historical data shows us that college costs have had an annual growth rate of 6.8% over the past two decades.
If costs continue on the same trend, then that $25,864 per year could grow to more than $84,000 in 18 years. And for a four-year education, the cost could be around $336,000.
That number sounds intimidating, and you might feel nervous that you’ll never be able to save that much. And it’s true — saving hundreds of thousands of dollars for a child’s education isn’t practical for many families.
But remember these two things when those worried thoughts creep in:
- Every little bit helps. Even if you can only save a few thousand dollars for a child’s education, that’s a few thousand less in student loan money they may have to borrow.
- Investing a child’s college savings can make an incredible difference. In the example above, saving from birth allowed the savings to more than double during childhood (from $43,000 to $90,000).
4 Ways to Save For College For a Baby
Now that we’ve talked about when to start saving and how much to save, let’s talk about the strategies you can use to save for a child’s future.
Choosing one type of account over another can actually make a huge difference. Let’s take a look at four possibilities.
A custodial account is a unique type of investment account that anyone can open on behalf of a child in their life.
The adult acts as the account custodian and manages the investments until the child reaches adulthood. Then, once the child turns either 18 or 21 (depending on the state), they take full control of the account.
There are two distinct types of custodial accounts:
- Uniform Gifts to Minors Act (UGMA) accounts
- Uniform Transfers to Minors Act (UTMA) accounts
A UGMA account and UTMA account have nearly identical features, with one main exception. While a UGMA can hold any type of financial asset, such as stocks, bonds, mutual funds, and cash, a UTMA account can also hold physical assets like real estate and collectibles.
The benefit of UGMA and UTMA accounts is that the child has complete flexibility. They can use the money for anything they want without worrying about a penalty.
So, they can spend the money on college. But if they decide not to go, they can also use that money for anything else.
Another advantage is that in the case of EarlyBird UGMA accounts, it’s easy for family and friends to collectively invest in a child’s future from the time they’re born, no matter who opens the account.
While there are some advantages to custodial accounts, there are also some downsides to using them for college savings.
First, custodial accounts don’t come with the same tax advantages as some other college savings tools.
Second, custodial accounts can result in a student being eligible for less financial aid than they otherwise might.
The assets in a custodial account belong to the student. And when it comes to determining how much a family can afford to pay for college, a student’s assets weigh more heavily than the parents’.
If your entire college savings was in a custodial account, you might find that your child doesn’t qualify for as much financial aid as you hoped.
Luckily, you can easily use custodial accounts alongside other savings vehicles.
A 529 plan is a type of college savings account that allows families to save for a child’s education with some serious tax benefits.
The most popular type of plan — the 529 college savings plan — allows families to contribute money to the account, invest it in various investment options, and withdraw it tax-free to pay for certain qualified education and college expenses.
And while there is no federal tax deduction for 529 plan contributions, there may be a state tax deduction.
529 plans are most beneficial when used for qualified expenses since you can withdraw the money tax-free. Qualified education expenses include:
- Tuition and fees
- Room and board
- Books and materials
- Internet access
- Special needs equipment
Another benefit of a 529 savings plan is its treatment for financial aid purposes.
When schools calculate how much financial aid a child is eligible for, they count 529 plans as the parent’s asset, not the child’s. And when calculating a child’s expected family contribution, the parents’ assets weigh less heavily than the child’s.
As a result, the assets in a 529 plan won’t reduce a child’s financial aid as much as the same amount of money in a UGMA or UTMA account would.
The biggest downside of 529 savings plans is the lack of flexibility. The money in these accounts is designed to be used solely for educational expenses.
If you use it for anything else, not only will you have to pay the taxes on it, but you’ll also pay a 10% penalty.
A custodial IRA — or individual retirement account — is a way for loved ones to begin saving for a child’s retirement before they reach adulthood.
What some people don’t realize is that these accounts can also be a way of combining retirement savings with college savings.
A Roth IRA is an account where you contribute with after-tax earnings. And because you’ve already paid taxes on the money you invest, you can withdraw your contributions at any time.
But here’s the thing — you can only withdraw the money you contributed. You can’t withdraw any earnings on those contributions.
Therefore, when a child in your life is ready to head off to college, you could withdraw the contributions to help pay for higher education expenses and leave the earnings to continue to grow for retirement.
However, Roth IRAs have an annual contribution limit of $6,000 or the child’s total earnings for the year — whichever is less.
So for a child with an annual income of $4,000, only $4,000 can be contributed to their Roth IRA that year.
Considering young people usually have to be about 14 years old to get a job, you’re likely to have less than $24,000 to withdraw by the time the child is gearing up to head off to college.
And while that's certainly a lot of money, it’s probably not enough to fund their entire education.
For many families, a savings account is the first thing that comes to mind when they think of saving for a child’s education. And it makes sense — savings accounts are accessible and simple to understand.
There are plenty of benefits to savings accounts. First, they’re easy to open, and many people already have one. If you have an account at your local bank, you can likely open another savings account in just a few minutes.
But there are also some serious downsides to savings accounts. Unlike the other accounts we’ve talked about, traditional savings accounts don’t provide much of a return.
Remember earlier when we ran the numbers of a family contributing $200 per month with an 8% annual return? We could expect the balance at the end of those 18 years to be around $90,000.
But what if you’d just put that money into a savings account? You would have had closer to $43,000 in your account — less than half as much as if you’d invested the money.
If there’s a new baby in your life, now is the perfect time to start saving for their college education. Not only does your money have plenty of time to grow, but you can help lessen the financial and emotional burdens that many families and other loved ones face down the road.
There are plenty of options for opening a college fund, each of which has its own benefits and downsides.
A UGMA account, in particular, offers ultimate flexibility to save for a child’s future collectively with friends and family. You can easily use it alongside other college savings tools, making for a powerful financial toolbox.
Download EarlyBird on the app store today to start investing in the kids you love.