Best Way To Invest Money For College

9 Minute Read | September 27, 2021

How much student loan debt do you think the average college student racks up by the time they cross the graduation stage? $5,000? $10,000? Think again. The average college graduate's student loan debt is a whopping $37,693.¹ And that's just the average!

The overall student loan debt in America is nearly $1.6 trillion.² Trillion!

At this rate, college graduates will be lucky to have their student loans paid off before their kids start college. As a parent, you're probably thinking there has to be a better way. Well, there is! You can start saving for college by opening a college fund. It's not easy, but with focused dedication, hard work and careful planning, it's possible to save enough so your child can go through college debt-free.

When Should You Start Saving for College?

As soon as possible! That's if you've already taken care of Baby Steps 1–4.

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Starting a college fund is a great goal, but it's not the only goal. You need to pay off debt, have an emergency fund, and start saving for retirement before you jump into saving for college. There are other ways to pay for college too, like using grants and scholarships. Bottom line, you need to take care of your future first, then you can bless your kids. It's not selfish. It's smart.

If you're following the Baby Steps, you know that saving for college is Baby Step 5. That means there are four other steps you need to take before you even think about Junior's college education:

Baby Step 1: Save $1,000 for your starter emergency fund.
Baby Step 2: Pay off all debt (except the house) using the debt snowball.
Baby Step 3: Save 3–6 months of expenses in a fully funded emergency fund.
Baby Step 4: Invest 15% of your household income in retirement (for instance, through your employer-sponsored retirement plan, like a 401(k) or a Roth IRA).

How to Start a College Fund

First, you need to figure out how much you need to save for college. Once you have that number, Dave recommends saving for college using these three tax-favored plans:

Education Savings Account (ESA) or Education IRA

An ESA works a lot like a Roth IRA, except that it's for education expenses. It allows you to invest up to $2,000 (after tax) per year, per child. Plus, it grows tax-free! If you put away $2,000 a year starting when your child is born, by the time they turn 18, you would have invested $36,000. It's hard to say exactly what the rate of growth is with an ESA because it varies based on the investments in the account. But at the average stock rate of 12%, that $36,000 would grow to around $126,000 by the time the child starts school. Congratulations, you more than tripled your investment, and now Junior doesn't have to worry about paying for tuition!

We like the ESA account because it's likely a much higher rate of return than you'd get in a regular savings account—and you won't have to pay taxes when you withdraw the money to pay for education expenses. An ESA isn't just for college tuition either. It can be used for K-12 private school tuition, vocational school or things like textbooks, school supplies or tutoring If your child doesn't end up needing it, you can transfer the money to a sibling for their school.

Why We Like It:

Variety of investment options
Grows tax-free
Higher rate of return than a regular savings account

Why We Don't:

Contributions are limited to $2,000 per year
You must be within the income limit to qualify
The amount must be used by the beneficiary by age 30

529 Plan

If you want to save more than $2,000 a year for your children's college education or if you don't meet the income limits for an ESA, then a 529 Plan could be a better option. But be careful—some 529 plans are no good. Look for one that allows you to choose the funds you invest in through the account. These are usually called "flexible" plans.

Dave warns against using a 529 Plan that would freeze your options or automatically change your investments based on the age of your child. Stay away from so-called "fixed" or "life phase" plans. You want to stay in control of the mutual funds at all times.

Like the ESA, the 529 can be used for other education expenses like K-12 tuition, vocational school or required college textbooks. The right 529 Plan will also give you the option to move the funds from one family member to another—but some 529 plans won't let you do this.

Why We Like It:

Higher contribution rates (varies by state, but generally you can contribute up to $300,000)
Most of the time, there aren't any income limits or restrictions based on age
Grows tax-free

Why We Don't:

Restrictions may apply if you choose to transfer your 529 Plan funds to another child

UTMA or UGMA (Uniform Transfer/Gift to Minors Act)

If you've already done an ESA and a 529 or if you don't qualify for an ESA, then and only then should you look into a UTMA/UGMA plan. This plan is different from ESAs and 529 Plans because it's not just for saving for college.

The account is in the child's name but is controlled by a parent or guardian until the child reaches age 21. Once the child turns 21 (or 18 for the UGMA), they'll be able to control the account to use any way they choose. So basically, you're just opening up a mutual fund in your child's name. You can use a UTMA/UGMA to save for college with reduced taxes, but it's not as good as the other options.

Why We Like It:

Funds can be used for more than just college expenses
Tax advantages for the contributor

Why We Don't:

Beneficiary can use money however they choose once of legal age (they could pay for a sports car instead of college)
Beneficiary can't be changed after selected

7 Simple College Savings Tips for Students

College is a privilege. Sure, most of us want our kids to pursue a degree, but that doesn't mean it's our responsibility to pay for it. It's totally okay for them to take some ownership in their education. Even though your child is a full-time student, there's no reason they can't start building up their own savings fund. At the very least, doing this will help establish healthy money habits they'll carry into the future.

Here are some great college savings tips to help them get started:

1. Apply for scholarships.

It's free money for college that you don't have to worry about paying back (and we like that). If your child excels in athletics, academics or extracurricular activities, they should try to get rewarded for it. Encourage your child to apply for any scholarship they're eligible for—even the small ones add up fast!

2. Apply for aid.

Everyone who wants to go to college should fill out the Free Application for Federal Student Aid, or FAFSA. It's a form schools use to figure out how much money they can offer the student. It covers things like federal grants, work-study programs, state aid and school aid—all different bundles of free money! But beware: The FAFSA also covers loans, which are a terrible idea. So, when an award letter arrives, read the fine print to make sure it's a scholarship or grant—not a loan.

3. Take AP classes.

Advanced Placement (AP) classes give high school students the opportunity to earn college credits while they're still in high school. Every AP class taken in high school is one less class you'll need to pay for in college. Hallelujah! Tell your child to talk to their academic counselor for more information.

4. Get a job.

Whether they take on a full-time gig during the summer or a part-time job during the school year, your child will be able to save money for college and gain work experience to put on their resumé.

5. Open a savings account.

If your student is serious about building up their college savings, they'll need a safe place to keep all that money. Most banks offer accounts specifically for students, which usually means waived monthly maintenance fees and no minimum balance requirements. If your child is under 18, you'll need to be the joint account holder.

6. Save money instead of spending it.

If your child gets birthday money or an allowance, suggest that they put it right into their savings account so they aren't tempted to spend it.

7. Never use student loans.

Student loans are not a last option—they're a non-option. Student loans may look like a quick fix, but they're a nightmare that sends college graduates out into the world anchored in debt. If your child can't pay cash by the time tuition is due, they should take some time off school and go to work.

It's Time to Get Serious About Saving for College

It's never too early to start thinking about a college savings plan. Whether your child is a teenager or toddler, the best time to start a college fund is now (but only if you've knocked out Baby Steps 1–4).

Making the right plan for your children's future starts with understanding all of your investment options. Connect with a qualified investment professional for free through SmartVestor. These are people we trust to take care of you and your child's college investment.

Want to learn more about how to go to school without loans? Debt-Free Degree is the book all college-bound students—and their parents—need to prepare for this next chapter. Grab a copy today or start reading for free to get plenty of tips on going to college debt-free!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.