How to Set Up a College Savings Account for Your Baby

If you’re expecting a child, you may find yourself thinking ahead to college. The cost of tuition continues to rise at public and private universities alike, with full-time in-state students at a public four-year university in California paying an average of $15,642 for tuition and fees in 2023. Meanwhile, tuition and fees at private universities in California cost an average of $45,382 the same year.¹

The price of higher education doesn’t have to mean racking up tens of thousands of dollars in debt. With college savings programs such as 529 plans and the Coverdell education savings account (previously known as an Education IRA), you can help your student offset the cost as soon as they’re born.

What is a college savings account ?

A college savings account is designed to help you save for elementary, secondary and higher education expenses. The best types of college savings accounts, like a 529 plan or Coverdell Education Savings Account (ESA), offer tax-advantaged strategies2 that may help you accumulate more money over time.

Of course, there are other options to help pay for college. Some families may use a custodial account (UTMA/UGMA), savings bonds or a Roth IRA. Financial aid — including scholarships — may also be available when your child is ready for college.

How do you decide which college savings option is right for your baby? Look for the best combination of tax advantages, financial benefits and flexibility while keeping to your overall financial needs.

What is a Coverdell Education Savings Account ?

A Coverdell Education Savings Account is a tax-deferred trust account created by the US government to help families fund educational expenses for beneficiaries, who must be under the age of 18 when the account is established. (This age restriction may be waived for special needs beneficiaries.) The total maximum contribution per year for any single beneficiary is $2,000.

Coverdell ESAs can be used to pay for qualified elementary, secondary and higher education expenses — and withdrawals made for these expenses are tax-free. The student must disburse funds before they turn 30.

There are income limits associated with Coverdell ESAs. If your modified adjusted gross income (MAGI) is above $220,000 for joint filers, you’re ineligible for the plan.

What is a 529 plan ?

Named after Section 529 of the Internal Revenue Code, 529 plans are investment accounts that allow you to set aside money for qualified education expenses without paying taxes on your earnings or interest on those savings.

Anyone can contribute to the account, and like a Coverdell ESA, the funds can be used for education expenses.

How do I set up a college savings account for my baby?

It’s relatively simple to open a 529 plan or Coverdell ESA. First, you’ll need to choose a provider. You’ll want to factor in the quality and cost of the plan, including enrollment fees and minimum contribution amounts before you decide. If you’re still unsure which college savings plan is right for you, contact a Patelco Certified Financial Specialist to help review your goals.

Next, you’ll need to designate the beneficiary — in this case, your baby — for the account and provide their date of birth and Social Security number. Most of these accounts can be set up online.

Once you’ve provided the required information, you’ll want to choose where to invest your money. Most experts will recommend using aged-based funds where the assets are adjusted automatically based on the child’s age.

Can I change the beneficiary of my baby’s college savings plan?

Anyone can be the beneficiary of a 529 plan as long as they are a US citizen or resident alien and have a Social Security number or tax identification number. You can change the beneficiary at any time without penalty.

If you’re setting up a Coverdell ESA, the designated beneficiary must be under the age of 18 unless they are a Special Needs Beneficiary. You can change the designated beneficiary once per year, but they must be a member of the beneficiary’s family.

How much can I invest in my child’s college savings account ?

A 529 plan offers the most flexibility for investing: There isn’t an annual contribution limit, but each 529 plan has a total lifetime contribution limit set by the state. California has one of the highest aggregate limits in the country: $529,000.

For Coverdell ESAs, the maximum annual contribution to any one beneficiary is $2,000.

Can grandparents contribute to my baby’s college savings accounts?

Yes, grandparents can help pay for college. In fact, anyone can contribute to a 529 plan or Coverdell ESA as long as the contributions do not exceed designated limits.

Do college savings plans affect financial aid packages ?

College savings accounts can affect financial aid packages — but the impact varies based on the type of plan and whose name the plan is under. Student assets and income are weighted more heavily than parent’s assets when calculating the expected family contribution (EFC) for financial aid. While grandparent-owned accounts aren’t used to calculate the EFC, disbursements from the grandparents’ accounts are treated as student income and may significantly impact your child’s eligibility for financial aid.

What if my child doesn’t go to college ?

You won’t be penalized for having leftover funds in a 529 plan after your child graduates or leaves college. If you withdraw your funds and use them for non-qualified expenses, however, you’ll have to pay income tax and a 529 withdrawal penalty on the earnings portion.

If your child has a Coverdell ESA and doesn’t go to college, they can withdraw the money from the account and pay taxes on the withdrawal. Any remaining funds will be automatically distributed to them when they turn 30.

You have other options, too. These plans allow you to withdraw funds to pay for vocational school, trade school and graduate school, as well as elementary and secondary school. The funds can be used to pay up to $10,000 in student loan debt, off-campus housing, books and required materials, and food and meal plans.

529 plans allow you to change the beneficiary to another child, so you could use the funds to pay for their education expenses or their student loans.