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Parents constantly lament how their children grow up so fast. In a blink, that baby turns into a toddler, and it’s just a few more blinks before that child is suddenly ready to attend college.

Hopefully, during those blinks, money is accumulating to pay for a college education. Because college can be expensive. Some parents choose to start a college fund when their child is just a baby and, for those who can afford to do so, this can be a wise decision.

If you’re going to start a college fund early, it’s important to strategically choose what type of account or accounts will hold that money. Some types of accounts have tax benefits, while others may require you to pay income tax on your earnings. There are also differences in contribution limits, how account money affects financial aid eligibility, and more.

Today, I’m going to highlight the pros and cons of the best college fund for babies. Consider starting an account sooner rather than later—you might just be a few blinks away from needing to pay for college.

How Much Should You Save for College Costs?

Keep in mind that you’re saving for an expense that’s roughly 15 to 18 years in the future. We’ll give you today’s numbers as a point of reference, but understand that you’ll likely need to pay even more when that first tuition bill arrives.

A recent study by Georgetown University’s Center on Education and the Workforce shows the average price for undergraduate education—including tuition, fees, room, and board—rose 169% from 1980 to 2019.

While the inflation-adjusted average for tuition and fees has declined a touch over the past couple of years, the cost of college remains high. The College Board found the advertised annual tuition and fees for a full-time undergraduate student at a four-year college during the 2022-23 school year averaged out to:

  • $10,940 at a public, in-state college
  • $28,240 at a public, out-of-state college
  • $39,400 at a private nonprofit college

For students living on campus at a public college, you should add an average of $12,310 for a dorm, meal card, and other expenses. For those living at a private college, expenses for room and board averaged $14,030 per year.

According to a 2021 survey by Fidelity Investments, around 25% of high schoolers’ parents and 38% of high school students were under the impression that a year of college costs just $5,000 or less! That shows how important it is to keep up with how much educational expenses really run these days so that you can adjust your college savings plan accordingly.

How Much Might College Cost If Your Child Is a Toddler in 2023?

It’s challenging to predict future college costs, as the rate of increase isn’t always consistent and college tuition for private colleges is higher than that of public universities.

The previous section showed current prices. Now let’s compare what college expenses looked like 30 years ago. According to the College Board, between 1992-93 and 2022-23, the average published tuition and fees, after adjusting for inflation, increased as follows:

  • Public two-year colleges increased from $2,340 to $3,860
  • Public four-year colleges increased from $4,870 to $10,940
  • Private four-year institutions increased from $21,860 to $39,400

The data shows that between 2012-13 and 2022-23, after adjusting for inflation, the tuition and fees actually declined by 1% at public, four-year institutions. Meanwhile, it increased by 6% at private, nonprofit four-year institutions.

It’s typically better to err on the side of caution when it comes to a college fund and save a bit more than you’ll expect you’ll need. As a rough starting point, you could assume that future tuition and related costs will simply rise in step with the overall inflation rate. Plug in, say, 3% annual inflation over the next 15 years, and the price tag for a public four-year college rises from last year’s $10,940 to $17,044. And that’s a pretty conservative estimate!

Best College Savings Accounts (Tax-Smart + Low EFC Impact)

Now, I’ll dive into what I believe are the best college savings accounts. We’ll start with those that have both tax advantages and a low impact on expected family contributions (EFC), an important metric in the Free Application for Federal Student Aid (FAFSA) that helps determine your child’s eligibility for financial aid.

For EFC, student assets are assessed at 20% (high), while parent assets are assessed at 5.64% (low). It’s rare, but some assets have no EFC impact.

1. 529 Plans

529 plan piggy bank college savings

529 plans are special tax-advantaged investment accounts for kids and adults saving for education expenses. The account allows you to contribute after-tax dollars that grow tax-free if used to pay for qualified education expenses for a designated beneficiary.

These investment vehicles are set up to defray the costs of formal education (thus keeping your child from piling up student loan debt) and have minimal impact on your financial aid eligibility. There are two types of 529 plans:

  • College savings plans: These accounts work much like a Roth IRA or 401(k), allowing you to invest after-tax dollars into mutual funds and other investment options. Your contributions grow tax-free, but how much they grow will depend on the performance of the investment options you choose to hold in your account.
  • Prepaid tuition plans: Prepaid tuition plans allow you to pay all or a part of your public in-state college education costs in advance through regular contributions. Generally, you can also convert the money to go toward a private or out-of-state college, as well, if your child decides not to attend an in-state public college.

529 college savings plans offer a more limited universe of investment options than joint brokerage accounts, custodial accounts, or IRAs. Most offer access to mutual funds administered at the state level, meaning that each state offers different investment options. However, you can choose to invest in one state’s funds and still use the proceeds to send your child to a college in a different state.

529 Accounts
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo
Annual Contribution Limits (2023)None (state limits might apply for state tax breaks)
Income Limits (2023)None
Growth of Funds (2023)Tax-free
Taxes on WithdrawalsNone if used for qualified expenses
Penalties on Withdrawals10% penalty on funds used for non-qualified expenses
EFC Impact (lower impact means more financial aid potential)Low impact (5.64%); parental asset on FAFSA (not included if owned by grandparent); withdrawals used for qualified expenses not included (withdrawals counted as untaxed student income if owned by grandparent)

529s with Backer

One of our favorite 529 plan providers is Backer. Backer is a hassle-free 529 savings plan where your family and friends can play a role, and it has helped families save more than $30 million toward college in just minutes.

You can use the 529 plan to put your child on track to afford college. Your money will be put to work in a portfolio of low-cost index funds that track major indexes of large-company stocks (S&P 500), small-cap stocks (Russell 2000), international-company shares (MSCI EAFE Index), and U.S. government bonds (Barclays Aggregate Bond Index).

Related: How Much to Save for Your Kid’s College [3 Tax-Smart Options]

What are qualified education expenses?

Qualified education expenses include tuition, fees, and other related expenses that eligible students incur when enrolling in or attending eligible educational institutions. Additionally, you can count necessary technology, such as computers or software, books, and student loan repayments (up to $10,000). For students attending at least half-time, room and board paid directly to the college is also included.

Some people are surprised to learn that transportation, insurance, cell phone plans, and fitness club memberships do not count as qualified education expenses. For some types of college investment accounts, earnings spent on anything outside qualified education expenses are subject to income tax as well as a penalty.

Related: Does My Child Have to File a Tax Return?

2. Coverdell Education Savings Accounts (ESAs)

books education graduation saving 529 esa coverdell

A Coverdell education savings account (ESA) is a custodial account or trust created to pay for a designated beneficiary’s educational expenses. Coverdell ESAs are lesser-known than 529 savings plans, but they work similarly. They also offer tax-free earnings growth and tax-free withdrawals, as long as the funds are spent on qualified education expenses.

However, the benefit doesn’t apply only to higher education expenses—qualified elementary and secondary expenses count, as well. (Some states allow 529 participants to use some of their account funds to pay for private K-12 education expenses, too.)

The account must be established prior to the beneficiary becoming an adult, unless the recipient has special needs. Contributions must be made in cash and aren’t deductible. Total contributions to the beneficiary can’t exceed $2,000 in any given year.

Coverdell ESAs
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo
Annual Contribution Limits (2023)$2,000 per beneficiary
Income Limits (2023)No contributions allowed if AGI is:
* $220,000 or more for joint filers
* $110,000 or more for single and head-of-household filers
Growth of Funds (2023)Tax-free
Taxes on WithdrawalsNone if used for qualified expenses
Penalties on Withdrawals10% penalty on funds used for non-qualified expenses
EFC Impact (lower impact means more financial aid potential)Low impact (5.64%); parental asset on FAFSA; withdrawals used for qualified expenses not included

Related: 5 Best Under-18 Investment Accounts [Invest as a Minor]

Other College Savings Accounts

This next group of college savings accounts aren’t as ideal for building up educational funds, but they still offer some benefits. You might consider these accounts if you have multiple savings goals in mind.

3. Custodial Accounts

custodial brokerage account kids small

Custodial accounts are run by an adult custodian (often a parent) for a beneficiary (usually a child). While the custodian can invest the money in the account, the funds legally belong to the child. The child gains control of the account once he or she reaches the age of majority for their state, which is typically when they turn 18 or 21 years old.

Withdrawn money must be used in ways that benefit the child, but there are many, many possible uses. One popular use of funds is for the child’s college costs.

However, if the funds don’t go toward paying for college, that’s fine too. There are no penalties for using the money in a custodial account for something else that benefits the child. Then, once the child takes over the account, the funds can be used for any purpose at all.

There are no limits on how much you can contribute to a custodial account, but you might not want to exceed the annual federal gift tax limit. For 2024, the limit is $18,000 ($36,000 for married couples filing a joint tax return). If you exceed the limit, you need to tell the IRS and you might have to pay gift tax on the excess amount (although in most cases you won’t owe any tax at that time). The IRS will deduct the excess amount from your lifetime estate and gift tax exemption, which is $12.92 million as of 2023 ($25.84 million for married couples).

YATI Tip: Both the annual limit and lifetime exemption are adjusted annually for inflation.

You’ll also have to pay capital gains taxes on any assets held in a custodial account if those assets are sold.

Taxable Custodial Accounts
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo
Annual Contribution Limits (2023)None (although gift tax exclusion is $17,000)
Income Limits (2023)None
Growth of Funds (2023)Earnings taxed as follows:
* $0 to $1,150 is tax-free
* $1,151 to $2,300 is taxed at the child’s tax rate
* $2,301 or more is taxed at the parents’ tax rate
Taxes on WithdrawalsCapital gains tax due on assets sold
Penalties on WithdrawalsNone
EFC Impact (lower impact means more financial aid potential)High impact (20%); student asset on FAFSA

Custodial accounts with EarlyBird

EarlyBird is a mobile app that allows parents and guardians to set up a custodial account so they can start investing for their children’s futures. Importantly, it also provides a convenient and inexpensive way to gift money to a child. And if you want to make it personalized, family and friends can record videos to go along with their financial contributions.

EarlyBird users invest in one of five strategic ETF-only portfolios, with investing goals ranging from conservative to aggressive, based on your stated risk tolerance and overall investor profile. And if you open an EarlyBird account today, you’ll receive $15 to get you started.

Related: 6 Best Investing Apps for College Students to Start Investing

4. Roth IRAs

roth ira retirement savings dollars

Roth individual retirement accounts (IRAs) are designed primarily for retirement savings, but there are other ways to take advantage of the tax-free growth they offer—including saving for college.

Like 529 plans, a Roth IRA investment account is funded with after-tax money and the earnings grow tax-free in your account. You can take the contributions out at any time, but withdrawing earnings before age 59½ or before you’ve had the Roth IRA for at least five years typically results in a 10% penalty.

However, there are a few exceptions to the penalty rules. One of them allows you to withdraw any amount from a Roth IRA to pay higher education expenses for yourself, your spouse, your child or grandchild, or your spouse’s child or grandchild. For this reason, Roth IRAs are sometimes used to save for college.

As with 529 plans, money from a Roth IRA can be used penalty-free for such things as college tuition, fees, books, room and board (the student must attend at least half-time), certain technology (such as a computer), and equipment for students with special needs. It can’t be used for student loan payments or K-12 tuition.

Roth IRA contribution limits

There are limits on how much money you can put in a Roth IRA each year.

First, contributions for the year can’t exceed the account holder’s “earned income” for the year. According to the IRS, earned income includes “wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services.” For instance, if a child earns $2,000 working at a part-time job during a calendar year, $2,000 is the most that can be contributed to her Roth IRA account that year.

There’s also an annual contribution limit based on your age; the limit is adjusted annually for inflation). For 2024, the annual Roth IRA contribution limit is $7,000 for people under age 50 (up from $6,500 in 2023). If you’re 50 or older by Dec. 31, 2024, you can put in an extra grand (the same as in 2023), for a total of $8,000.

When is a Roth IRA better than a 529 plan?

If you’re not sure your child will attend college, your savings might be better off in a Roth IRA than a 529 plan. That’s because you can just keep the money in the account and let it continue to grow tax-free for your child’s eventual retirement if you don’t end up using the money you saved for his or her college education.

Roth IRAs
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo (although Saver's Credit might apply)
Annual Contribution Limits (2023)$6,500 ($7,500 for age 50 or older)
Income Limits (2023)No contributions allowed if AGI is:
* $228,000 or more for joint filers
* $153,000 or more for single and head-of-household filers
Growth of Funds (2023)Tax-free
Taxes on WithdrawalsNone after age 59½ if Roth account open for 5 years
Penalties on Withdrawals10% penalty on earnings if withdrawn before age 59½ or no Roth account for 5 years
EFC Impact (lower impact means more financial aid potential)No impact; not included on FAFSA; withdrawals counted as income

Betterment Roth IRAs

Betterment’s Roth IRAs make investing easy by funneling investors into low-cost ETFs from major fund providers. It’s best for people who want to “set it and forget it,” though you can connect with human advisors to get guidance on your account. (The option to talk with a financial professional makes Betterment pretty unique among robo-advisors.)

Related: Roth IRA for Kids: Can I Open a Custodial Roth IRA for a Child?

5. Taxable Brokerage Accounts

brokerage account father daughter laptop tablet

A taxable brokerage account can work well as a college savings account because there are no contribution limits and it has the most investment options. Money invested strategically has the chance of significantly increasing in value. Plus, the money can be used for anything if your priorities change and you don’t want to use the money towards college expenses.

However, there are no tax benefits and you have to pay taxes on all gains. For this reason, other types of dedicated college savings accounts can be superior.

Taxable Brokerage Accounts
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo
Annual Contribution Limits (2023)None
Income Limits (2023)None
Growth of Funds (2023)Taxable
Taxes on WithdrawalsCapital gains tax due on assets sold
Penalties on WithdrawalsNone
EFC Impact (lower impact means more financial aid potential)Low impact (5.64%); parental asset on FAFSA

Invest with Robinhood and get free stock

Robinhood is a pioneer of commission-free trading, jumping into the investing public’s consciousness in 2013 when they rolled out commission-free trading. They remain a standout option for cost-minded investors thanks to their continued $0 commissions on stocks, ETFs, and options, as well as for its fractional trading, which allows people to invest with as little as $1.

Once you’ve signed up with this link and are approved for a brokerage account, just connect your bank account or debit card, and Robinhood will give you between $5 and $200 that you can use to buy fractional stock, chosen from a list of “20 of America’s leading companies.”

Related: 11 Education Tax Credits and Deductions for 2023

6. Savings Accounts

savings account piggy bank

The benefits of savings accounts is that they are safe and interest-bearing vehicles for building up funds for future expenses. Additionally, the money can be used for anything. It isn’t restricted to educational costs, so there is no penalty if you need to use some or all of the money for other expenses.

However, the money in a savings account doesn’t have nearly as much growth potential as money in most investment accounts. Plus, these accounts don’t have tax advantages and you must report the interest on your federal income tax return.

Parents have the option of having a college savings account in their names or their child’s name.

Savings account in the parents’ name

When parents use their own name to open an account for college savings, the money is considered an asset of the parent. Financial aid formulas only consider 5.64% of that money as available for their child’s college education. In other words, it doesn’t have a substantial impact on financial aid eligibility.

Savings account in the child’s name

A savings account in the child’s name means the money is considered the child’s asset. In this situation, financial aid formulas consider 20% of the money as available college savings, which has a much more significant impact on financial aid eligibility.

Savings AccountsParentChild
Nature of ContributionsAfter-taxAfter-tax
Tax Deduction For ContributionsNoNo
Annual Contribution Limits (2023)None (although FDIC insurance is only up to $250,000)None (although FDIC insurance is only up to $250,000)
Income Limits (2023)NoneNone
Growth of Funds (2023)TaxableTaxable
Taxes on WithdrawalsNoneNone
Penalties on WithdrawalsNone (bank fees might apply)None (bank fees might apply)
EFC Impact (lower impact means more financial aid potential)Low impact (5.64%); parental asset on FAFSAHigh impact (20%); student asset on FAFSA

Save With Step Banking

Step, made popular by its unique “hybrid” Step Visa Card, has expanded its offerings to include a powerful high-yield savings tool.

Users earn 5% annually—compounded and paid monthly—on up to $250,000 saved in their Savings Goals, calculated using the average daily balance in your Savings Goals. To qualify, the user must have a direct deposit of at least $500 per month, and the benefit extends for as long as the direct deposits continue. (Other perks of making qualifying direct deposits? Bonus points on dining, food delivery, charitable donations, specific merchants—and you can get paid up to two days early.)

Related: Best Savings Account Alternatives [Other Ways to Save]

Savings Bonds

education tax credits savings bonds

Another option is to buy your savings bonds as a part of a college savings plan. Usually, savings bonds’ interest becomes part of the holder’s gross income for tax purposes. However, under certain conditions, the bondholder doesn’t have to pay taxes on all or part of the interest if the money is used to pay for higher education for themselves, a spouse, or a dependent. This education exclusion is calculated on a pro rata basis.

You can claim the education exclusion on Form 8115, which you’ll file with Form 1040.

The owner of the bond must be a minimum of 24 years old when the bond is issued to qualify for the education exclusion, which is why the savings bond should be held in the parent’s name, rather than the child’s.

The savings bonds that qualify are Series EE or I savings bonds that were issued after 1989. The series EE is typically the more appropriate option, though I savings bonds could be more lucrative if inflation ends up being high over time.

Savings Bonds
Nature of ContributionsAfter-tax
Tax Deduction For ContributionsNo
Annual Contribution Limits (2023)$10,000 in electronic EE bonds
$10,000 in electronic I bonds
$5,000 in paper I bonds that you can buy when you file federal tax forms
Income Limits (2023)* Education exclusion phaseout begins at 128,650 (married filing jointly) and $85,800 (all other returns)
* Education exclusion ceiling of $158,650 (married filing jointly) or $100,800 (all other returns)
Growth of Funds (2023)Tax-free if used for qualified expenses
Taxes on WithdrawalsNone if used for qualified expenses
Penalties on Withdrawals10% penalty on funds used for non-qualified expenses
EFC Impact (lower impact means more financial aid potential)Low impact (5.64%); parental asset on FAFSA; withdrawals used for qualified expenses not included

Related: Student Loan Interest Deduction: How Much, Eligibility + More

FAQs About College Savings

questions faq raised hands question mark

What is the best college fund for a baby?

The best college fund for baby future scholars is likely a 529 college savings plan. These accounts have tax advantages as long as the money is used towards qualified expenses. And a relatively low percentage (5.64%) counts toward expected family contributions. Plus, you can now do several things with unused money in a 529, including transferring some into a Roth IRA.

Parents aren’t limited to just one type of college savings plan, so they can always open more than one type if they are so inclined.

When should I start a 529 college savings plan?

The best time to start a 529 college savings plan is as early as possible, even if you can only start out with a small amount of money. The earlier you begin an account, the more time the investments have to grow and compound.

Some people think they should wait to start a 529 college savings plan until their child decides for sure to attend college. However, if that child doesn’t attend college, you have several ways to use that money without sacrificing the tax benefits. For instance, the account can be transferred to another qualifying beneficiary, or the money can be transferred into a Roth IRA for the child (up to a $35,000 cap).

Just make sure your finances are in order—including having a healthy retirement savings plan—before contributing significant money to a college fund. Your child can always borrow to attend college; you can’t borrow to fund your retirement!

Should I start a 529 plan before my child is born?

You cannot name an unborn child as the beneficiary of a 529 college savings plan because the child doesn’t yet have a Social Security number. You can create an account and name yourself as the beneficiary, however. Once your child is born and has a Social Security number, you can change the beneficiary to your child.

Some states might have age limits for who can be named as the beneficiary, so you might need to wait a bit longer.

While you usually can start a 529 college savings plan before your child is born, should you? The answer largely depends on the current state of your finances. If you haven’t started saving for retirement yet or have started, but consider yourself very behind, you should first focus on getting yourself on track for retirement. Anyone already on track for retirement should open a 529 account as soon as possible so the money has ample time to grow, assuming they are confident that they will be having children in the future.


About the Author

Riley Adams is the Founder and CEO of WealthUp (previously Young and the Invested). He is a licensed CPA who worked at Google as a Senior Financial Analyst overseeing advertising incentive programs for the company’s largest advertising partners and agencies. Previously, he worked as a utility regulatory strategy analyst at Entergy Corporation for six years in New Orleans.

His work has appeared in major publications like Kiplinger, MarketWatch, MSN, TurboTax, Nasdaq, Yahoo! Finance, The Globe and Mail, and CNBC’s Acorns. Riley currently holds areas of expertise in investing, taxes, real estate, cryptocurrencies and personal finance where he has been cited as an authoritative source in outlets like CNBC, Time, NBC News, APM’s Marketplace, HuffPost, Business Insider, Slate, NerdWallet, Investopedia, The Balance and Fast Company.

Riley holds a Masters of Science in Applied Economics and Demography from Pennsylvania State University and a Bachelor of Arts in Economics and Bachelor of Science in Business Administration and Finance from Centenary College of Louisiana.