Last week, I wrote about simple steps for funding your child's education. Today, we'll explore the single best college savings plan in more detail.
According to a recent Wall Street Journal article, the cost of tuition at a four-year state university has more than doubled during the past two decades. Even worse, this figure is adjusted for inflation. Sadder yet, our incomes haven't come close to keeping up. In fact, a typical middle-class family's income increased a meager 7% during that same 20-year period.
Obviously, we can't control the escalating costs of a college education. Yet we can control how we save for college and how much money we set aside for it. The only way to come close to outpacing the rising cost of college is investing in growth-oriented securities. Doing so in a tax-free account is even better.
The single best way to save for education
The tax-advantaged 529 college savings plan lets you sock a ton of money away for your kid's education because of its very generous contribution limits. You don't pay federal or state taxes on withdrawals from a 529 plan as long as the money is used for qualified higher-education expenses. That includes costs associated with universities, junior colleges, and trade and vocational schools.
Since many states grant tax deductions up to a certain dollar amount on contributions to their plans, investing in your state's sponsored 529 plan may offer even more tax advantages. While state-sponsored plans are a great way to go, you can generally enroll in any 529 plan regardless of where you live. Check out more about state-sponsored 529 plans here.
Drawbacks and other options
One downside of 529 plans is the limited array of investment options. For example, if you go with a specific mutual fund company's plan, then you must choose solely from its lineup of funds. Another drawback is that you need to wait 12 months before you can change the investment allocation or transfer the money to another plan. Yet while there exist shortcomings to the 529 plan, it's still the best solution out there.
Other ways to save for college include Coverdell and custodial accounts. Coverdells provide significant tax benefits (similar to the 529) that the custodial account doesn't, but you can only contribute $2,000 annually per beneficiary to a Coverdell. Distributions can fund education expenses from kindergarten through college. Like the Coverdell, custodial account money doesn't have to be used exclusively for college. But once you've contributed money to a custodial account, you can't take it back. The money becomes an asset of the child as early as his or her 18th birthday (depending on the state of residence and how the custodial account was created ).
Get started today
Don't let the rising cost of college discourage you. The worst college savings strategy is the lack of one. Consider the 529 plan today. It's the single greatest solution for securing your child's future.
Fool contributor Nicole Seghetti can be followed on Twitter @NicoleSeghetti. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.