Saving for College: Frequently Asked Questions

This depends on how much you think your children's education will cost. The best way is to start saving before they are born. The sooner you begin the less money you will have to put away each year.

Suppose you have one child, age six months, and you estimate that you'll need $120,000 to finance their college education 18 years from now. If you start putting away money immediately, you'll need to save $3,500 per year for 18 years (assuming an after-tax return of 7%). If you wait until the child is six years old, you'll have to save almost double that amount every year for twelve years.

Another advantage of starting early is flexibility: you'll be able to put at least part of your money in equities which, although riskier in the short‑run, are better able to outpace inflation than other investments in the long‑run.

It depends on whether your child attends a private or state school. According to the College Board, for the 2022–23 school year the total expenses—tuition, fees, room and board, personal expenses, and books and supplies—were about $57,570 per year for the average four‑year private college and about $27,940 per year for the average four‑year in‑state public college. Some private colleges can exceed $80,000 per year, whereas some state options can be kept under $10,000 per year. In 2022–23 the average amount of grant aid for a full‑time undergraduate student was about $8,690 and $24,770 for four‑year public and private schools, respectively, and more than 75% of full‑time students receive grant aid.

Choose investments that provide a good return and match your risk tolerance. The mix depends on when you start—what you use for a toddler should differ from what you use if the child is age 12.

• Series EE savings bonds. Extremely safe; generally held in the parents' names. If your income is under the thresholds at redemption and the proceeds are used for qualified expenses, interest can be tax‑free.
• U.S. Government bonds. Higher potential returns than CDs/EE bonds; zero‑coupon bonds can be timed to when funds are needed. Accrued interest is taxable even if not received until maturity, and selling early can cause losses.
• Certificates of deposit (CDs). Safe but often earn less than inflation. Interest is taxable; best for short horizons and very low risk tolerance.
• Municipal bonds. For higher tax brackets, tax‑free interest can be attractive. Zero‑coupon munis can mature when funds are needed. Convert tax‑free yields to taxable equivalents to compare properly: taxable‑equivalent yield = tax‑free yield ÷ (1 − tax rate).
• Stocks / stock mutual funds. Over long periods, equities have historically outperformed bonds. Consider broader stock funds when starting early; income/balanced funds may suit shorter timelines.

The American Opportunity Tax Credit (AOTC) provides up to $2,500 per eligible student for the first four years of post‑secondary education. For most taxpayers, 40% (up to $1,000) is refundable.

Income limits. To claim the AOTC, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). For the Lifetime Learning Credit, MAGI must not exceed $69,000 ($138,000 for joint filers).

Eligible costs. Tuition and required fees, plus books, supplies, and equipment needed for a course of study—whether or not purchased from the institution. Room and board and most activity fees are not eligible. You cannot claim a credit for amounts covered by tax‑free scholarships, Pell grants, or employer‑provided assistance, and you cannot claim both a credit and a deduction for the same costs.

The kiddie tax limits income‑shifting to children. In 2023, the amount that reduces the net unearned income subject to the kiddie tax is $1,250. One requirement for a parent to elect to include a child's income is that the child's gross income exceeds $1,250 but is less than $12,500. The net unearned income for a child under age 19 (or a full‑time student under age 24) that is not subject to kiddie tax is $2,500. Earned income is always taxed at the child's rate.

In 2023, you can contribute up to $2,000 per year to a Coverdell ESA for a child under 18. Contributions are not deductible, but grow tax‑free and qualifying withdrawals are tax‑free. Contributions may be made through the unextended due date of the return for that year.

The $2,000 limit is phased out for modified AGI between $190,000 and $220,000 (joint filers) and $95,000 and $110,000 (single filers). Only cash may be contributed, and contributions stop after the child turns 18. Anyone—including the child—can contribute, but total annual contributions for a beneficiary cannot exceed $2,000 across all accounts.

• Save as much as possible during the remaining years, even if it won't fully close the gap.
• Consider part‑time work for you and/or your student (note: higher income may reduce some need‑based aid).
• Tap assets prudently: home‑equity or personal loans, selling assets, or borrowing from a 401(k) plan.
• Apply for student aid and education loans (see grants and loans sections).

Grants do not have to be repaid and may be need‑based or merit‑based.

• Federal Pell Grants are need‑based.
• State education departments may offer grants.
• Employers may provide subsidies.
• Private organizations and most schools provide scholarships (need‑based and non‑need‑based).
• Military scholarships may be available via the Reserves, National Guard, or ROTC.

Try negotiating with your preferred college for additional aid, especially if a comparable college offered more.

• Stafford loans. Federally guaranteed; subsidized (need‑based) and unsubsidized versions.
• Perkins loans. Federally provided and school‑administered; need‑based (check availability with the school).
• PLUS loans. Federally guaranteed loans to parents of undergraduates; also supplemental loans for students.
• Institutional loans. Some schools offer their own loan programs.

• Avoid putting assets in the child's name; assets/income of the student reduce aid eligibility more heavily.
• Reduce taxable income in the base years: defer gains, harvest losses, adjust business income, avoid retirement plan/IRA distributions, and pay taxes during the year.
• Reduce discretionary assets by paying off credit cards and other consumer loans.
• Use tax‑deferred vehicles like 401(k)s, other retirement plans, or annuities.
• Document financial hardships clearly in your aid applications.
• In some cases, a student qualifying as independent can increase aid; see federal criteria.

• Shift just enough assets to generate up to $2,500 of a child's 2023 taxable income while under age 19.
• Buy U.S. Savings Bonds (in the child's name) scheduled to mature after age 18.
• Favor equities with low dividends and long‑term appreciation to minimize current taxable income.
• Employ your child in a family business for legitimate work—earned income isn't subject to the kiddie tax; if a sole proprietorship and the child is under 19, Social Security taxes may not apply.