While you can certainly sock away money for college in a piggy bank or savings account, there are better ways to save.
The best option for most people is a 529 plan. These accounts, which earn their name from the section of the tax code that created them, are kind of like IRAs for college. While contributions can’t be deducted from your federal taxes as IRA savings can, you may be able to deduct the amount you save from your state taxes. Plus, your earnings grow tax-free, as with an IRA. And if you spend the profits on approved college costs — including tuition, books, room, and board — you can withdraw the money tax-free as well.
There are a few caveats, of course. For one, if you withdraw the money for non-educational purposes, you’ll pay taxes on earnings plus a penalty. Second, your child’s eligibility for need-based aid can be reduced each year by up to 5.64% of any non-retirement savings including 529 balances, though typically the impact on aid is smaller than that.
There are two types of 529s:
Self-directed college savings plans allow you to invest money that can be applied to costs at any accredited college. You can choose from a limited set of investment options, which typically include pre-made portfolios based on the child’s age. These start off very stock heavy and then shift toward bonds, which tend to be safer, as your child’s college enrollment date nears. Although most college savings plans are sponsored by states, you can invest in any state’s 529, even if you don’t live there or have a child planning to attend college there. See “What’s the best 529 plan for me?” for help determining which state’s plan to choose.