Saving for your child’s future can be challenging, especially with college tuition rising at twice the rate of inflation. The good news? Starting early gives your savings time to grow, and there are several tools to help reduce education costs. Here are a few options to consider.

529 Savings Plans

A 529 plan is an education savings plan operated by a state or educational institution. These plans are relatively hands-off and work much like a 401(k) or IRA, with your contributions invested in mutual funds or similar investments. Your account will go up and down in value based on the particular investment’s performance in the stock market. If the market takes a nosedive, your plan could too.

Tax benefits

The major advantage of the plan is its tax benefits. Although contributions are not deductible federally, earnings in a 529 plan grow tax-free and will not be taxed as long as the money is withdrawn to pay for specific college-related expenses such as tuition, fees, room and board, and course materials. Money withdrawn and spent on unqualified expenses is subject to income tax and a 10% penalty on the earnings.

You can switch beneficiaries within the plan. If your firstborn opts out of the college route, a younger sibling can become the beneficiary of the plan without penalty. Another great benefit is that the plan is considered your asset, not your child’s. This could help your child get more financial aid when applying to schools.

What are the contribution limits?

There is no income limitation to take advantage of these plans. However, the contributions are considered gifts to the beneficiary of the plan. Currently, you can make up to $19,000 ($38,000 if split with your spouse) in gifts each year to any person and not be subject to the gift tax. The 529 plan allows you to make an election to front-load the contributions of up to $95,000 per beneficiary ($190,000 for a married couple) and treat it as if it was made ratably over a 5-year period. This avoids any gift tax because you are under the $19,000 annual exclusion for each of the 5 years.

An added benefit is that these funds are considered to be removed from your taxable estate, yet you retain full control over the account, including the right to change beneficiaries. Each plan differs in the maximum value allowed for each beneficiary. For most plans, the maximum is between $350,000–$500,000. 529 plans are not only a great way to save for college but also a powerful estate planning vehicle.

The Tax Cuts and Jobs Act (TCJA) modified 529 plan rules, allowing plans to distribute up to $10,000 for expenses related to tuition for elementary or secondary public, private, or religious schools. This limitation applies on a per-student basis. A student may be a designated beneficiary of multiple accounts but may only receive a maximum of $10,000 in distributions across all accounts for the tax year. As private K-12 school tuition rises similar to college tuition, this could be a great option to help defray the costs.

Prepaid 529 Plans

Prepaid tuition plans let parents lock in today's college tuition rates by paying in advance, which can be a great way to save as costs continue to rise. These plans offer the same tax and financial aid benefits as 529 savings plans but aren't tied to stock market performance.

However, if your child attends an out-of-state school, the return on your investment may be less than if the funds were used as intended. Be sure to compare different prepaid plans, as requirements and benefits can vary widely.

Roth IRA Accounts

Once your child gets a little older and has earned income, you can open a Roth IRA in the child’s name. Each year you can contribute the lesser of the child’s earned income or $7,000. The contributions are made with after-tax money, and the assets grow tax-free. Children over 18 retain control of the account, but restrictions prevent the account holder from taking withdrawals until the age of 59 ½ penalty-free (with a few exceptions). Funds can be taken out tax-free for the purchase of a first home or for qualified education expenses.

Recently, Congress took steps to mitigate the problem of having leftover funds in a 529 plan that will likely never be used for educational purposes. Beginning in 2024, the SECURE 2.0 Act of 2022 allows for an opportunity to make direct tax-free rollovers from a 529 plan to a Roth IRA

Rolling over 529 funds to a Roth IRA comes with strict rules. The 529 account must be at least 15 years old, and rollovers can only go from the beneficiary’s 529 plan to their own Roth IRA. Contributions and earnings from the last five years cannot be rolled over. There’s a $35,000 lifetime rollover limit per beneficiary, and rollovers must follow the annual Roth contribution cap ($7,000 for 2025), with no income restrictions.

Before choosing a savings plan, consider your own long-term financial goals to ensure a secure future for both you and your child.