What accounts are best for college savings?

March 11, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Q: I want to open savings accounts for my two grandsons to start putting aside money for their eventual college education, but I don't know what approach to take. Any advice?

A: Starting an education fund for a grandchild is a generous and thoughtful idea. Education costs are spiralling out of control, leaving many students heavily burdened with debt by the time they graduate. The earlier you get a jump on saving to offset these costs, the more educational opportunities your grandchildren are likely to have, and the less debt burden they will have as they start their careers.

Here are three things that can help you select the right type of savings vehicle for your grandchildren:

  1. Consider the time frame. You mention savings accounts, and while that is one possibility, you should make sure the type of account matches the amount of time left before your grandsons will start spending this money. If college is still a decade or more in the future, it might not be the best idea to keep all the money in short-term deposit vehicles like savings accounts. Incorporating some stocks into these education funds can provide them with a growth element to help get ahead of inflation. Then, you can start to transition to more conservative investments as the kids near college age.
  2. Look into a 529 fund. You might find it advantageous to save this money inside a Section 529 plan. While contributions to 529 plans are not tax-deductible, any investment earnings on those contributions are tax free as long as they are ultimately used for the beneficiary's education expenses. Most states nowadays have a wide variety of 529 plans available, which will give you a range of options for choosing an appropriate investment vehicle within this kind of tax-advantaged program. As with any tax-advantaged account, there are rules and limitations that apply to 529 plans, so be sure you understand these before committing your money. The IRS web site is a good source for information on these plans.
  3. Use special checking accounts for students to avoid fees. Once your grandchildren enter college, you may want to help them set up checking accounts to handle their routine expenses. Since the typical student generally maintains a relatively small account balance, fees are a critical issue. While free checking has become more rare in recent years, there are still free checking accounts available, and some banks offer special accounts that cater especially to students.

Speaking of education, as your grandsons get older you can use these college savings vehicles to start teaching them some fundamentals of personal finance. That will equip them with necessary life skills that most people aren't taught in school.

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