Your Complete Guide to Starting a College Fund for Baby

April 16, 2021
investment strategy

There’s nothing in life that’s cause for more joy than a new baby coming home from the hospital. But even before a new baby enters the world, it’s natural to start worrying about the costs associated with raising that child.

In addition to all the costs the family will incur over the next 18 years raising that baby, there’s also the cost of college to worry about.

In 2021, the average cost to attend a four-year college or university is $25,615 per academic year. Many families feel overwhelmed by the price tag and don’t know where to start.

In this article, we’re breaking down everything you need to know about starting a college fund for a baby in your life. From how much to save to what type of account to open, we’ve got it all covered.

How Much Should You Save for College?

One of the biggest questions many adults have for the educational future of a child in their life is how much they should save for college. 

It’s a fair concern. 

The costs of higher education rise so rapidly, it’s hard to keep up. The goal you set when a child is born may no longer be enough when they head off to college. 

Data shows that from 2001 to 2021, the cost of in-state tuition and fees at a public university has increased 212%. This was, surprisingly, the largest increase, compared to 144% for tuition and fees at private universities and 165% for out-of-state tuition and fees at public universities.

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It’s also difficult to estimate college costs because there’s so much that goes into them. 

The average cost of in-state tuition is $9,580 per year. But the total cost of attending a public university for a single year is $25,615. 

When you add in fees and other costs associated with higher education, the price tag more than doubles. And the total cost of receiving a four-year public university education is currently $103,456.

Most adults likely see these figures and wonder how they could ever save enough to send a child to college.

The good news is that thanks to the investment accounts available today, you don’t have to save it all yourself. As long as you’re contributing to a college fund, compound interest can help your money grow even faster.

If you saved $100 per month in a savings account from the time a child is born until the time they turn 18, you’d end up with roughly $21,800, since the average interest rate of a savings account in the U.S. is only a measly 0.07%

If you invest $100/month into a savings account with 0.07% interest for 18 years, you'll only end up with $21,837.28

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Unfortunately, that’s not enough to cover even one year of average costs at a public university.

But what if you’d invested that money instead?

If you’d invested that same $100 per month with a 10% annual return (the average, according to the U.S. Securities and Exchange Commission), you’d end up with $55,275.

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As you can see, this still isn’t quite enough to cover the entire cost of a degree from a four-year university. But you’re more than halfway there.

And if you can swing an investment of $200 per month, then you’ve fully funded four years at a public university.

When you look at the cost of college as one big number, it’s easy to feel overwhelmed. But when you break it down into a monthly goal, it’s suddenly far more manageable.

When Should You Start Saving for College?

It’s never too soon to start investing in a child’s future, whether that’s saving for a child’s college education, or putting money aside for other life goals. 

As we discussed in the previous section, compound interest really helps your money grow as you contribute to a child’s financial freedom and independence.  

And the most important component of compound interest? Time.

We’ve already talked about the importance of investing in college rather than just saving for it. 

But it’s also important to discuss the value of investing early, rather than waiting until the child is just a few years away.

Let’s say you put your money into an investment account with a 10% annual return. 

If you start contributing $100 per month from the time a child is born until the time they turn 18, you will end up with $55,275. And depending on where that child goes to school, it could very well be enough to fund their entire education. 

Unfortunately, data shows that most families don’t start saving when a child is born. Instead, the average age a child is when their family starts saving for college is seven.

So what happens when you make that same $100-per-month contribution with a 10% return? 

With seven fewer years to save and for that money to compound, you ultimately end up with about $22,523. Your savings have been cut in half just by losing those first seven years.

compound interest calculator chart over 11 years

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Now, let’s look at what happens when a family waits until a child starts high school or turns 14 to start saving. 

With just four years for your money to grow, you’d have only $5,716 by the time the child heads off to college.

And it’s not simply a matter of putting less into the account. 

If you invest $100 per month for 18 years, you ultimately contribute $21,600. If you invested that same amount ($21,600) when your child started high school, you’d still end up with just over $30,000. 

It’s not bad, but it’s considerably less than you got by investing the same amount over a longer period.

compound interest calculator chart over 4 years

This math applies no matter what financial goal you’re saving for. 

Many adults save for a child’s college education. But the same rule of thumb is relevant no matter what your saving goals. To give a child the gift of financial freedom, the earlier you start, the better. 

How to Start a College Fund for a Baby

There are two main savings tools that adults can use to save for the college education of a baby that they love.

529 College Savings Plan

A 529 college savings plan is a tax-advantaged investment vehicle to help save for qualified education expenses. 

When you contribute to a 529 plan, your money grows tax-free. And as long as it goes toward educational expenses, you won’t pay taxes on your earnings.

529 plans can be used to pay for most of the costs associated with higher education, including college tuition, fees, textbooks, computers, rent, and more. 

Because they’re meant for education expenses, there are some penalties to using that money for anything else. 

First, you’ll pay taxes on your earnings. Then, you’ll also pay a 10% penalty on those earnings. That being said, if a child chooses not to attend college, the funds can be transferred to another beneficiary.

The other benefit of the 529 college savings account is that they have a limited impact on financial aid. 

Money in a 529 plan account owned by a child’s parents is considered the parents’ asset. Schools only expect parents to use about 5.64% of their own assets to pay for college, compared to 20% of the child’s.

There’s one important exception: 529 plans owned by anyone but the parents, meaning grandparents, godparents, and other loved ones, are considered the children’s assets. As a result, they’ll weigh more heavily against financial aid.

Pros of the 529 plan:

  • Tax-free growth on investments
  • High contribution limits
  • Favorable financial aid treatment

Cons of the 529 plan:

  • Limits on what the money can be used for
  • Limited investment options

Custodial Account

A custodial account is a type of investment account that an adult opens for a child. The adult, known as the custodian, manages the account and makes all the investment decisions. Then, when the child reaches adulthood, they take full control of the account and can use it for anything they wish.

Contributions to custodial accounts are irrevocable gifts. Once they go into the account, they legally belong to the child and can’t be taken back.

Custodial accounts offer significantly more flexibility than 529 plans. First, the child can use the money for anything.

custodial accounts offer much more flexibility than 529 plans

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They’re also far more flexible in terms of your investment portfolio. 

There are two types of custodial accounts: an UGMA account and an UTMA account. 

An UGMA account can hold just about any financial asset, including stocks, bonds, funds, insurance policies, cash, and annuities. An UTMA account can hold all the same types of financial assets, as well as physical assets like real estate.

The downside of these accounts is that they don’t come with tax savings like 529 plans. They also have less favorable treatment for financial aid. Money in a custodial account is the child’s asset, meaning they weigh more heavily against financial aid.

Pros of the custodial account:

  • Total flexibility
  • No contribution limits
  • Many investment options

Cons of the custodial account:

  • Fewer tax advantages
  • Unfavorable financial aid treatment

If you’re considering opening a custodial account for a child in your life, EarlyBird might be just what you’re looking for. 

EarlyBird offers a simple and innovative option for custodial accounts. Any loved one can easily set up an account and then invite other friends and family to invest in the child’s financial future collectively.

The benefits of an EarlyBird account go far beyond saving for a child’s college education. First, gifts to a child’s EarlyBird account have an emotional impact, as you can record a video memory for the child with every donation. 

And the money in a custodial account can provide ultimate financial freedom for a child’s future.

Using the 529 Plan and Custodial Account Together

We’ve talked about the pros and cons of both the 529 college savings plan and the custodial account. And you might be wondering how to decide between them. Rather than looking at it as a one-or-the-other situation, consider how you can use the two together. 

The 529 plan offers advantages for college savings that a custodial can’t compete with. It comes with incredible tax advantages and reduces a child’s chances of missing out on financial aid. But it does have some shortcomings. 

First, 529 plans are designed to be used for qualified higher education expenses. 

If a child decides not to attend college and you use the money for something else, they will pay taxes on their earnings, as well as a 10% penalty. 

Plus, there are some college-related costs that 529 plans can’t be used for. Those costs include your child’s transportation costs, groceries, and other spending money.

By using the 529 plan and the custodial account together, you’re covering all your bases. 

You’re gaining the tax advantages of the 529 plan, as well as planning for those expenses it won’t cover. You’re also covering your bases in case the child decides not to attend college or to at least postpone it for a few years.

A child could use the 529 plan to cover their college expenses, then use the money in their custodial account to start a new life after graduation.

Tips on Saving for College

Saving for college is no small feat. Here are a few other tips to make the process a bit easier.

  • Start early: You can’t save for a child’s education all in one day. Instead, it’s about small and consistent action over many years.
  • Invite friends and family to join: All of the loved ones in a child’s life will be excited to invest in their financial future. When you open a custodial account through EarlyBird, you can easily invite loved ones to contribute.
  • Encourage your teen to get a part-time job: When a child makes an investment in their own future, it means even more to them. Encouraging a teen to get a part-time job and invest some of their money can help increase their college savings and create a greater sense of ownership over their future.
  • Apply for scholarships: There are thousands of scholarships available to help young people cover the cost of college. There are merit and need-based scholarships, scholarships for students with particular hobbies and interests, scholarships for students studying a particular subject, and more.
  • Student loans: A child going into debt for college isn’t a perfect solution, but sometimes it’s the best option. A student loan can easily help bridge the gap between the cost of college and what a family is able to save.

Conclusion

College is one of the biggest expenses most families will have for their children. And unfortunately, the large price tag leads many young people to rely on student loans to get their degrees.

But thanks to compound interest, the earlier you start saving, the better. By starting a college fund for a baby in your life today, your money has time to grow into an even larger sum by the time the child heads off to college.

An UGMA account is one of the easiest and most flexible ways to save for a child’s future. When paired with other college savings vehicles, it can help provide the ultimate financial freedom when that child reaches adulthood. 

Download EarlyBird on the app store today to start investing in the kids you love.