Should You Save for College in a Regular Savings Account?

You could -- but you may not want to.

Attending college is hardly an inexpensive prospect these days. The average cost of annual tuition and fees at a private university is $39,723 for the 2022-2023 academic year, according to U.S. News & World Report. For a public out-of-state school and in-state school, these figures drop to $22,953 and $10,423, respectively. But that's still a lot of money to shell out.

What makes saving for college particularly tricky is that unless you start doing so before even having kids, you only get a limited window to sock money away. For retirement savings purposes, you might have a good 40 years to build yourself a nest egg, assuming you start to save for your senior years in your 20s and retire in your 60s. But many students start college at age 18, which gives you a shorter time frame for building up a college fund for your kids.

Now, if you're eager to help your children fund their education, you may be thinking of keeping that money in a regular savings account. But doing so could mean falling short of your goals.

Why a regular savings account may not cut it

These days, you might snag a 4% interest rate on your savings by keeping your money in the bank. But there was a point in time not so long ago when you could barely eke out 1% on your savings by keeping it in the bank. And you need your money to grow at a faster pace than that to build up a nice college fund.

That's why you're generally better off investing your college savings -- or at least some of it -- rather than keeping it all in cash. If you invest your money, you might generate twice the return that savings accounts are paying today -- or eight times the return they were paying just a few years ago.

Where to invest your college savings

You have different options when it comes to housing the money you're saving for college. One is to open a brokerage account and invest there. But in doing so, you won't reap any tax benefits. And when you take withdrawals to pay for college expenses, you'll be subject to capital gains taxes. That's why you may want to opt for a Roth IRA or a 529 plan instead. 

Roth IRAs allow you to take penalty-free withdrawals at any age to pay for higher education. Plus, withdrawals and investment gains are tax-free. 

To be clear, though, if you're going to save for college in a Roth IRA, you should open a separate account for that purpose. You shouldn't dip into your own Roth IRA meant for your retirement to pay for your kids' college.

Meanwhile, a 529 plan is a savings plan specifically designed for education costs. The benefits are similar to those offered by Roth IRAs -- tax-free investment gains and withdrawals. The only problem with 529 plans is that you'll be penalized on the gains portion of your account if you take a withdrawal for non-education purposes.

So, let's say you wind up in the enviable position of having saved $200,000 for your kids' college expenses, but because they've chosen less expensive schools and gotten scholarships, your total college costs only come to $100,000. Now, let's say that of your remaining $100,000 in your 529 plan, $50,000 of that represents investment gains. That means you could face a 10% penalty on that $50,000 if you use the money for purposes other than education. 

Make sure your money gets to grow

College costs seem to be going nowhere but up, so you need to invest your money in a manner that can keep up. It's easy to see why you may be inclined to stick to a regular savings account for your college fund. But investing that money, whether in a brokerage account, Roth IRA, or 529 plan, is really a much more efficient way to go.