What's the best way to save for college for your child?

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Unless you live under a rock, you know about the growing problem of student loan debt. Student loan debt has grown to such size that it’s the second largest consumer debt in the country (just after mortgages) at $1.26 trillion, according to USA Today.As parents we want our children to be able to attend college if they choose. However, unless you want your child saddled with debt, we need to save money to make that happen. This is where the best college savings plans come into play. There are various options, each with its own benefits and drawbacks. Here are some options to consider to guide your savings efforts.

When should you start saving for college?

Choosing the college savings vehicle that best suits your needs is obviously important. However, a common question is, "When should you start saving for college?" Sooner is obviously better as you give the investment time to grow, but when should you jam it into your budget? "No matter the investment approach, it's important that parents start early… waiting until life calms down to start saving could hurt in the long run," says CNN.When asking yourself the question of when to begin saving, you need to make sure you have other needs covered. Make sure you have the following things covered first:

  • An emergency fund

  • That you’re saving for retirement

  • Your basic insurance needs are covered

Covering these bases allows you to cover both short- and long-term needs, not to mention protecting your family.

What are the best college savings vehicles?

You may not realize it, but there are a wide variety of college savings vehicles to look at if you want to start saving for college. Below are three of the best ones to consider.

Option #1 – Coverdell Educational Savings Account (ESA)

One of the first options parents should consider to save for college are Coverdell ESAs. Think of a Coverdell ESA like you would a Roth IRA – contributions are not tax-deductible, but withdrawals, so long as they’re for qualified educational expenses, are tax-free.Benefits of a Coverdell ESA include:

  • Can be used for any educational expense, from kindergarten to college

  • Many online brokers offer Coverdell ESAs, so they're great for self-directed investors.

  • Earnings are tax-free, just as with a Roth IRA

Unfortunately, Coverdell ESAs might be too restrictive for some people:

  • You can only contribute $2,000 per year. While you can have multiple accounts per child, the total across all accounts you can contribute per year is $2,000. Over-contributions are taxed.

  • The IRS has an income limit on Coverdell ESAs. If your modified adjusted gross income (MAGI) is over $220,000, if filing a joint return (or $110,000 if single) then you can’t contribute to a Coverdell ESA.

A Coverdell ESA may be a good way to start saving for college, but be sure they fit your financial situation before you consider them over other options.

Option #2 – retirement accounts

It may seem odd, but you can use your retirement savings to help send Junior to college – five percent of parents did this in 2016, according to Sallie Mae. While long heralded for their ability to help us save for retirement, IRAs (either Traditional, Roth, or SIMPLE IRAs) can be used as a college saving vehicle – if done in the right way.Here are some of the reasons why you may want to consider using retirement funds as a means to pay for college:

  • With a Roth IRA, in particular, you can withdraw contributions tax-free for qualified college expenses. So, for example, if you contributed $5,000 per year over the past five years you could withdraw $25,000 to pay for college expenses.

  • Withdrawals from other types of IRAs avoid the early distribution tax, per IRS rules.

  • The IRS also allows for funds to be used for room and board if the student is enrolled at least half-time, and on items for special needs students.

Of course, whenever you withdraw funds prematurely from your retirement savings, there are going to be drawbacks. Some of those are:

  • You’re still on the hook for taxes if you withdraw gains from a Roth, as well as on any Traditional or SIMPLE withdrawals.

  • You may impact financial aid eligibility. Retirement accounts aren't counted in aid calculations, but when you take a distribution, you lose that benefit.

  • You put your retirement at risk.

We love our children and want the best for them, which means protecting them from student loan debt. However, you can put your retirement at risk when you dip into the funds you’ve been saving up. At last check, they don’t offer loans for retirement. Junior may appreciate that help getting through college, but will his college degree be worth the cost of putting you up in his house when you’re old and gray?

Option #3 – 529 plans

529 plans are considered by many to be the most robust college savings vehicle available. There are a lot of features that make 529 plans quite attractive for many families, including:

  • You can contribute more money than with other options. The IRS allows contributions up to the point that they don’t exceed the qualified educational expenses. There is also no income restriction for contributions.

  • Grandparents may be able to give up to $14,000 per year before hitting the gift tax exclusion. The IRS also allows you to front-load contributions for up to five years for a maximum contribution of $70,000 at once.

  • You don’t have to open the 529 in your state – you can pick one that has features you like.

  • Earnings grow tax-free, and distributions for qualified educational expenses are tax-free.

  • Funds in 529 plans are transferable. If you have a child who doesn’t go to college, but you saved funds for him in a 529, you can transfer his funds to a sibling.

While a great option to consider, 529 plans are not perfect. Here are some drawbacks to keep in mind:

  • There are potential tax issues. If you pull funds out for a non-qualified expense, you're subject to a 10% penalty as well as taxes.

  • Contributions are not tax-deductible. Some states offer tax deductibility, but they’re not deductible on your federal taxes. Here's a list of deductibility possibilities, by state.

  • Limited investment options. You may find that some plans have limited, or high-cost, investment options. However, since you get to choose what plan works best for you, this isn't as big of a problem as it might seem.

The benefits to a 529 plan are clear, especially if you have younger children and can take advantage of the higher contribution limits.

Do your homework

Saving for college is not a minor undertaking. There are many things to consider, from taxes to if you think your child will even attend college. If need be, engage a tax advisor for assistance selecting the best option for you from a tax perspective, so you don't overlook savings opportunities. Keep in mind, as well, that while you love your children, you need to examine saving for college within the broader scope of your entire financial picture.Don’t forget to look for other opportunities to save for college, from scholarships and grants to attending a local community college to save money in the beginning. As your children get older, bring them into the loop so they can begin to know what to expect. You never know, it may even help them become financially literate.