The Complete Guide To Starting A College Fund For Kids

September 27, 2021
investment strategy

It doesn’t matter whether you’re a parent, a grandparent, an aunt or uncle, or just a family friend. You want to help contribute toward a college fund for the kids in your life.

The problem is knowing how to get started. You probably have a million questions, such as: 

  • When should you start a college fund?
  • What’s the best college fund for a child?
  • What’s the cost of going to college?
  • Should you open a separate college fund for each child?
  • Can others contribute to my child’s college fund as well?
  • Can you set up a college fund for your grandchild, or if you’re not the child’s guardian?
  • What happens if your child doesn’t go to college?

Thankfully, there are fairly straightforward answers to all of these questions.

This article will answer all of these questions about a college fund for kids and more.

When Should You Start A College Fund? 

When it comes to starting a college fund, it’s best to do it as early as you can.

Some family members might be able to start saving for the child in their life as soon as the child is born.

For others, it might make sense to get their own finances in order before they start saving for a child’s college fund.

If you’re in a position to start saving when a child is young, it will definitely put them in a better position later on. 

However, students always have the option to receive financial aid or take out a student loan. You don’t always have a similar option to cover your retirement or living expenses. 

So if you’re not yet in a secure financial position yourself, focus on that first. 

Should You Invest or Just Put It In a Savings Account? 

Your first instinct might be to keep your hard-earned college savings in a bank account as cash where there’s little to no risk.

But the truth is, keeping a child’s college savings as cash can be riskier than investing it into a college fund. 

You have inflation and the rising costs of tuition to compete against. So, without a way to continually grow your education savings over time as a child grows up, your money will slowly lose its value and purchasing power over time.

There are several different kinds of college funds available to choose from, including a custodial UGMA account, a 529 plan, Coverdell ESA, and Roth IRA. 

The pros and cons of saving and investing
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What Is The Best College Fund For A Child?

There are several different options when it comes to starting a college fund for a child. Let’s walk through the main four:

Custodial account

You can use a custodial account, such as a UGMA (Uniform Gifts to Minors Act) account, to save money for non-qualified education expenses or anything else that a student in your life might want to pay for.

The money isn’t restricted to just paying for things like tuition and books. Your loved one can use money set aside in this kind of account for whatever they need.

A custodial account’s flexibility allows you to really invest in a child’s future and start building wealth for them, as opposed to simply saving for college.

529 plan

A 529 college savings plan is the most commonly used type of college savings account. It’s a tax-advantaged college savings plan that’s designed to help pay for education. Sometimes it’s also referred to as a qualified tuition program or a Section 529 plan.

A 529 savings plan is administered at a state level. Some states may offer financial incentives that make a 529 plan a more attractive investment option than others.

One type of 529 plan is a prepaid tuition plan, which allows you to pay future college tuition at today’s rate.

Coverdell ESA

This is another type of tax-advantaged savings account that’s used to save for education expenses like college tuition.

A Coverdell ESA provides more flexibility in investment options than a 529 plan but has a lower annual contribution limit. You also can't fund a Coverdell ESA once the beneficiary is over 18, and they must spend the savings by the time they’re 30.

For a full breakdown of the differences, see our Coverdell vs. 529 article.

529 plan vs. Coverdell ESA comparison
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Roth IRA

A Roth IRA is an individual retirement account. As the name suggests, its primary purpose is saving for retirement. 

However, the money you put into a Roth IRA can also be withdrawn and used to pay for qualified expenses without paying federal income tax or penalties.

For a full breakdown, see our article about using a Roth IRA for college. It goes more in-depth into the advantages and disadvantages of using this type of account as a college fund.

What’s right for you?

Each of the options above has its own advantages and disadvantages. You’ll need to evaluate and figure out the best way to save for college, given your own personal and financial situation.

It’s also not an all-or-nothing choice where all of your money needs to go into one type of account. Parents and family members may have several different college funds for the child in their life.

The different types of accounts you could use for a college fund serve different purposes as well. 

For example, you might use a 529 plan to cover the cost of tuition. But you might also save money in a custodial account to help a child pay for their day-to-day expenses.

What’s The Cost of Going To College? 

The cost of college tuition tends to increase at about two times the rate of inflation each year. 

You can expect to pay around $24,700 per year for a student who's currently 16 years old to attend an in-state college. 

In contrast, a child who's currently two years old can expect to pay $55,900 per year for the same college when it’s time for them to go.

Of course, the total cost of a child attending college will depend on the program they attend. A two-year or four-year program will cost significantly less than a master’s or Ph.D. Schools differ in cost, too.

You’ll need to set a realistic goal for yourself. 

Given the future costs of education for the child in your life, your plan could be to cover anywhere from 0–100% of the total college expense.

Most parents will pay anywhere from 30%–50% of a child’s college costs. 

The remainder is usually paid for using scholarships, grants, loans, financial aid, and contributions from relatives or friends.

average cost of tuition and fees with graph adjusted for inflation
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College Fund FAQs

Let’s take a look at some commonly asked questions about starting a college fund for a child.

Should I open a college fund for each child? 

Some college funds like a Coverdell ESA only allow for one beneficiary to be listed per account.

For others like a 529 plan, it’s technically possible to use one account to fund the education of multiple different children.

However, it’s generally a best practice to set up a separate college fund per child. That way, you can keep things fair and contribute an equal amount to each fund separately. 

As long as you choose a low-fee college savings plan, the difference between having one college fund or multiple should be negligible. 

Can I set up a college fund for my grandchild?

Yes, a grandparent can set up any of the account types we discussed above for their grandchild.

Some options that are less appealing to parents might be a better option for grandparents or aunts and uncles.

For example, the $2,000 annual contribution limit on a Coverdell ESA might be less of a deterrent to a family member who only wants to contribute a small amount each year.

A 529 plan also allows for superfunding, where grandparents can make up to five year’s worth of contributions (up to $75,000) in a single year.

Different types of college funds may or may not also provide a tax deduction to grandparents as a contributor.

Can others contribute to my child’s college fund as well?

Yes, there are ways that you can contribute to most types of college funds, even if you weren't the one that created the account.

All 529 plans accept third-party contributions. You can contribute via electronic payment or check. Some 529 plans even have gifting platforms that allow parents to receive funds via email.

The same is true for Coverdell ESAs. Grandparents, aunts and uncles, or even family friends can contribute to a child’s account. However, the amount from all sources can’t exceed $2,000 per year.

EarlyBird’s app is one of the simplest ways for family and friends to collectively invest in a child’s financial future. Plus then the money is available for non-education expenses as well.

grandparents' annual spending on grandchildren pie chart
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Can I open a college fund if I’m not the child's parent or custodian?

Yes, you can open a 529 plan or ESA for any child in your life.

There are drawbacks to doing this, though, especially because each person who wants to contribute to the child’s savings could end up setting up their own account. 

With this approach, a child might end up with half a dozen different college funds by the time they go to college, each with a few thousand dollars in them. 

It’s just a lot easier to keep all of the money in the same place.

EarlyBird allows parents, family, and friends to all collectively invest in a child’s financial future in one convenient place. Our app makes it simple and fun to gift contributions to a child’s account for any occasion.

What if the kid doesn't go to college?

One of the pitfalls of investing in a college fund is if the child ends up not needing it.

A 529 plan or Coverdell ESA will allow you to transfer the account to another beneficiary. But unless there’s another child in your life whose college fund you want to contribute to, this won’t help much.

You can always just withdraw the money from their college fund and give it to them as cash. However, you’ll pay steep penalties and taxes for doing this.

If you’re saving for a family member or friend, it might be a better option to set up a custodial account like a UGMA or UTMA from the start.

That way, the child can use your financial aid to pay for whatever they need once they’re old enough without it being restricted to qualified higher education expense items. 

It’s basically like setting up a trust for the child in your life without going through all of the legal hassle.

Start Saving For The Kids in Your Life Today

The price of college tuition is constantly on the rise. You’ll want to set up a college fund for kids in your life to help provide them with the best opportunities possible.

You can set up a custodial account, 529 plan, Coverdell ESA, or Roth IRA as a college fund for kids.

Keep in mind, you don’t have to choose just one type of account.  

Download the EarlyBird app today and see how simple it is to start setting up the child in your life for financial freedom.

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