Starting a College Fund for Your Baby: 3 Account Types for 2025

Setting up a college fund for your baby can take many forms, including a 529 plan, Roth IRA, or a taxable brokerage account

Why do so many people think about a college fund for your baby within days of his or her birth?

If you’re among the Millennials who continue to pay off student loan debt, you already know. If you’ve just become a new parent (congrats!), you already know. And even if you’re still awaiting the birth of a child, you already know.

A college education is expensive.

What’s New for 2025: Turning a College Fund for Your Baby Into a Roth IRA

In late 2022, Congress passed the SECURE 2.0 Act. One provision in the act gave parents an option to transfer funds from a 529 college savings account to a Roth IRA. The transfer includes three important characteristics:

• The transfer would be tax-free;
• The transfer would not trigger penalties;
• and the funds would not need to be spent on educational expenses.

The IRS published additional guidance last year. The relevant section on the IRS website reads:

“Qualified tuition program rollover to a Roth IRA. Beginning with distributions made after December 31, 2023, a beneficiary of a section 529 qualified tuition program is permitted to roll over a distribution from a section 529 account into a Roth IRA for the beneficiary if certain requirements are met.”

There are several rules and limitations to consider before taking advantage of this new option. I suggest reading this article by Ben Henry-Moreland before making any decisions in 2025 or the years ahead.

The Main Reason to Consider a College Fund for You Baby

You’ve likely heard that the cost of college has far outpaced inflation over the past two decades. Even formerly affordable options have become more expensive.

Over the past 20 years, according to a recent report by U.S. News that looks at 436 ranked national universities:

• Private tuition has increased by 126%
• Out-of-state tuition has increased by 112%
• And in-state tuition has increased by 133%.

In comparison, inflation has risen by about 60% over that time.

Recent Trends in College Costs That May Impact Your Baby

College costs likely will continue to increase before your child reaches college. Even so, signs suggest that tuition increases may be slowing.

The College Board produces a report called, “Trends in College Pricing.” Their data indicates that:

• Published in-state tuition and fees at public four-year institutions declined by 1% since 2012 after adjusting for inflation. They had increased by 37% between 1992 and 2002, and by 65% between 2002 and 2012.
• Overall, total tuition, fees, and room and board have increased 2% at public four-year institutions over the last decade. They’ve increased by 6% at private non-profit four year institutions. Both of those rates are slower than the current rate of inflation.
• Finally, the average net tuition that students actually pay has declined in recent years. Over the past decade, first-time, full-time students at public two-year colleges have received enough grant aid on average to cover their tuition and fees.

What is the Cost of College in 2025?

Let’s look at college costs for the current school year. The amounts below include tuition and room and board. They also include books, supplies, and transportation. According to EducationData.org, college costs:

• $27,146 for public four-year in-state students
• $45,708 for public four-year, out-of-state students; and
• $58,628 for private nonprofit four-year students.

Over four years, these students will pay $108,584, $182,832, and $234,512 for a college degree.

Not surprisingly, then, a college fund for your baby can be a make difference down the road.

A College Fund for Your Baby: What’s Your Personal Goal?

Are you thinking to yourself, “Right now I feel worried about paying for childcare. How will I ever save that much money?” Or, “If I’m going to give my kids the same opportunities that I had, I’ll have to make extreme sacrifices in my own lifestyle in order to be able to afford college.”

It’s easy to feel paralyzed when you consider such a vast sum of money. Especially in the current economic moment. 

But it shouldn’t. If you start to save for your child’s college early, either before or soon after they are born, then the accumulation of compound interest over the years will mean that even the smallest investments will balloon by the time your child is ready to decorate a dorm room.

It doesn’t have to mean that you sacrifice your own retirement savings, or even your quality of life, over the years. And you don’t necessarily have to work with a financial advisor for Millennials.

Instead, focus on a dedicated, reasonable monthly investment in a college fund for your baby. This amount can make up a small part of your budget. But it still can have a profound impact, whether you start at birth or in the years after. Even contributions early in high school can make a difference.

Remember, you don’t have to pay for every penny of your child’s education. Your job as a parent is to not only provide financial support, but also to help your child to navigate the complicated world of financial obligations, including college tuition, with knowledge and patience.

Saving for Your Baby’s College Education: 3 Great Account Options

Your options for setting up a college fund for your baby include a few key differences.

Some are better if you only have a certain amount to invest annually and fall below a certain income level. Some are great if you would like to suggest to family friends and relatives that they donate to a college fund as opposed to buying your child plastic toys on birthdays and holidays. And others are better if you value flexibility and freedom.

Below, I outline three investment accounts that will work for most Millennials with kids:

1. 529 College Savings Plan
2. Roth IRA
3. Taxable Brokerage Account

Let’s review a few pros and cons of each account type. 

What is a 529 Plan?

When you think about a college fund for your baby, the phrase “529 plan” likely comes to mind. It’s the most common type of college fund. And is likely one that you’ve already considered if you’ve investigated saving money for your child’s future education.

529 plans originated in Michigan in the early 1990s with the Michigan Education Trust (MET). The state government runs MET, a prepaid tuition program in which residents pay a fixed amount in exchange for future tuition at a Michigan-run institution. Other states quickly adopted similar programs, and the IRS eventually codified the programs into Section 529 of the Internal Revenue Code (IRS) in 1996.

At its most basic level, a 529 plan is a tax-advantaged savings account available to all United States residents over the age of 18 regardless of income. The beneficiary of a 529 plan must also have a social security number (which means that you can’t open such an account for a baby in utero) and can even be the same person who sets up the account.

You can use money accrued in a 529 plan for a range of educational expenses, including college tuition, K–12 tuition, certain apprenticeship costs, and even student loan repayments. And the money you invest in a 529 can contain a mixture of pre-set investment portfolios including mutual funds, index funds and cash.

If you live in Washington, DC, I’ve previously shared details and tips about the DC College Savings Plan that you may want to check out.

Advantages of a 529 Plan for Your Baby’s College Fund

There are plenty of advantages to using a 529 plan.

As long as the money stays in the account, it is not subject to federal income tax. When it is withdrawn specifically for educational purposes, the money is also free from federal income tax, and in many cases, free from state taxes as well. (Follow this link for a map that outlines deductions by state for 529 plans.) Some states, including New York and California, even give individuals grants to invest in their 529 programs. 

There are no annual contribution limits to 529 plans. Individuals can contribute up to $16,000 annually per beneficiary without triggering the federal gift tax. Additionally, the federal government allows individuals to contribute a one-time lump sum of $80,000 ($160,000 for couples) without eating into the gift-tax exclusion, which means that if you suddenly have a financial windfall, you can contribute to the account in a large amount without having to pay federal taxes. Or, you can ask a very generous grand-parent or loved one to do the same.

The account holder keeps control of the money for the beneficiary, which means that they make all financial decisions. A 529 plan also allows other people – family members, friends, parents – to make contributions to the account through a gift account that can be set up through the brokerage firm, and functions something like a GoFundMe with tax advantages for a college education.

One final benefit of a 529 plan is that distributions from the account won’t count against your child’s financial aid package if they need to apply for one. In essence, the money in a 529 plan won’t increase your child’s income on paper, making them eligible for less money overall.

Disadvantages of a 529 Plan for Your Baby’s College Fund

While you may know what’s best for your child, in the end, they may decide that college is not right for them.

In that case, the money in the 529 account can only be withdrawn with steep penalties, including 10% federal tax penalty, along with state and local penalties. (Such penalties may be waived if a student attends a military academy or receives a scholarship that makes the money in a 529 plan extraneous.) If this is the case, some of the net gains you make from a long-term investment may be lost if the money isn’t used for education.

What is a Roth IRA?

Originally established as a type or retirement savings account in federal legislation introduced by the late Delaware senator William Roth in 1998, Roth IRAs have become an additional way to save for college.

Unlike 401(k)s and traditional IRAs, Roth IRAs are funded by after-tax dollars (meaning that you contribute to them after you pay your taxes), and grow tax-free. Distributions from the account, including earnings, are tax-free after the age of 59 ½, and can be left in entirety to heirs.

Holders of Roth IRA accounts can withdraw their contributions – but not their earnings – tax free before retirement age. All earnings withdrawn before retirement age are subject to a 10% penalty, except for distributions used to pay certain types of expenses, including college fees.

The federal government allows parents to withdraw money from a Roth IRA to pay for college without paying any penalties, although such withdrawals are subject to income tax if the account holder is less than retirement age. (In certain cases, first-time homebuyers also receive an exemption from this withdrawal rule.)

Advantages of a Roth IRA for Your Baby’s College Fund

The main advantage of a Roth IRA is its flexibility. If your child decides not to go to college, you can keep the money you saved in your account for retirement. Because all your savings are in one place, you could technically accrue more money with interest with the caveat that people under the age of 59 ½ cannot contribute more than $6,500 a year (as of 2023) to a Roth IRA account.

Disadvantages of a Roth IRA for Your Baby’s College Fund

The federal government ultimately created the Roth IRA for low and middle income families.

As a result, the IRS does not allow individuals earning more than $144,000 in 2022 ($153,000 in 2023) and married couples filing jointly earning more than $214,000 ($228,000 in 2023) to make contributions to Roth IRA accounts.

Other people can contribute to Roth IRAs on your behalf, but they’re constrained by the income caps and contribution limits inherent in the plans. Which means that, unlike a 529 plan, if you have a very rich great-aunt, she cannot suddenly decide to fund two years of college tax-free through a Roth IRA.

One final disadvantage is that income withdrawn from a Roth IRA is counted in the Free Application for Federal Student Aid, or FAFSA, calculation, which means that if you use a Roth IRA to fund a college education, your child may be eligible for less generous financial aid packages.

What is a Taxable Brokerage Account?

A taxable brokerage account functions much like a bank account. The primary difference is that you can use it to buy and sell stocks, bonds, mutual funds, and ETFs. Unlike a 529 Plan or a Roth IRA, investment income that you accrue in a taxable brokerage account is subject to capital gains tax and must be paid yearly.

You personally own the funds in your taxable brokerage account, which means that you can withdraw them any time for any reason, including for your child’s college tuition. There are no limits on the amount of brokerage accounts you can own, or the amount that you can contribute to them annually.

Advantages of a Taxable Brokerage Account for Your Baby’s College Fund

A Roth IRA gives your options. But a taxable brokerage account gives you true flexibility.

You can do anything you want with the money invested, including paying for a year of college tuition, or helping to fund your child’s lemonade business. While being subject to federal, state and local taxes, of course. 

Another benefit of a taxable brokerage account is that you have more options in terms of investments. Whereas a 529 plan or a Roth IRA generally only lets you choose between a few different stock and bond funds, with a taxable brokerage account, you can invest in a wide range of assets including index funds and cryptocurrency. (On a side note, please don’t invest in cryptocurrency.) 

Disadvantages of a Taxable Brokerage Account for Your Baby’s College Fund

The capital gains taxes that the IRS leverages on a brokerage account are tiered between 0%, 15% and 20%, depending on your income. They tax higher incomes at a higher rate. This means that if you save a nice chunk of change for your child, it may very well be subject to a significant tax upon withdrawal, leaving you with less money overall to pay for the total cost of college. 

The Most Important Thing to Remember When You’re Starting a College Fund for Your Baby

Deciding which type of college fund to use is a personal decision that is informed by your income level, investment savvy, and plans are for your children’s future.

Maybe you are the type of parent who will happily help fund your child’s college education, but balk at providing them with a cushion if they decide to forgo school. Maybe you know that your income will grow over the years, and as a result, you’ll start by investing in a Roth IRA, and then begin adding any extra money you have to a 529 plan. Or maybe you’d like to have more freedom and flexibility in choosing how you use your money, which is why you’ll favor a taxable brokerage account.

Whatever investment strategy works best for your life, the best thing I can encourage you to do is start saving for college today, in any amount. Like, right now. No matter how small the contribution.

Compound interest — and the benefits it can provide to your family — waits for nobody. 

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Recommended Money Reads for Millennials

If you liked this article, you may also want to check out:

• Investing in a Roth IRA for a Child
• The Best Ways to Take Advantage of Government TSP Matching

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About Kevin Mahoney, CFP®

Hi, I’m Kevin. I’m the founder of Illumint and a financial advisor in Washington, DC. I specialize in financial planning for Millennials like you. As a Millennial father and Certified Financial Planner™, I empower our peers to invest with confidence and flexibility. If you’re new to Illumint, I’m glad you’re here – you now have access to free personal finance tips written specifically for Millennials. I encourage you to read, watch, or listen to the ideas I share about exchanging your money for memories with your kids. And then when you’re ready, please send me your thoughts & questions!