Education Planning: Options to Save for College
Saving and putting money away for college can be an effective way to avoid student loans for your future graduate. Your family has choices of where to put college savings to help keep it safe and hopefully grow before tuition bills show up. Keep reading for considerations on a few possible destinations for your family's higher education dollars.
529 college savings plans
Offered by states and some educational institutions, these plans allow you to save large amounts for a child’s college costs without having to file an IRS gift tax return. However, an individual or couple’s annual contribution to a 529 plan cannot exceed the yearly gift tax exclusion set by the IRS. You may be able to front-load a 529 plan with a large initial contributions per plan beneficiary—up to five years of gifts in one year—without triggering gift taxes.
Remember, a 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. State tax treatment of 529 plans is only one factor to consider before committing to a savings plan; the fees and expenses associated with the particular plan should also be considered. Whether a state tax deduction is available will depend on your state of residence. State tax laws and treatment may vary and may be different from federal tax laws. Earnings on non-qualified distributions will be subject to income tax and a 10% federal penalty tax.
If your child doesn’t want to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from a 529 plan into another 529 plan established for the same beneficiary (or another family member) without tax consequences.
Grandparents can also start a 529 plan or another college savings vehicle. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself.
Start a 529 Birthday Tradition
Coverdell ESAs
Coverdell Education Savings Accounts (ESA) are sometimes referred to as education IRAs. This is due to many of the similarities these accounts have to an IRA. A Coverdell can be set up at a financial institution of your choosing. You can then choose from a wide variety of ways to invest and grow education dollars. Coverdell ESAs are not available for everyone. The IRS maintains income limits on who can start and contribute to this type of account. Be sure to check IRS rules or with a professional to ensure eligibility.
Contributions to Coverdell ESAs aren’t tax-deductible, but the accounts enjoy tax-deferred growth, and withdrawals are tax-free, as long as they are used for qualifying education expenses. Contributions may be made until the account beneficiary turns 18. The money must be withdrawn when the beneficiary turns 30, or taxes and penalties may occur.
"An intelligent heart acquires knowledge, and the ear of the wise seeks knowledge." Proverbs 18:15 ESV
UGMA & UTMA accounts
These all-purpose savings and investment accounts are often used to save for college, and take the form of a trust. When you put money in the trust, you are making an irrevocable gift to your child. You manage the trust assets until your child reaches adulthood and the trust terminates. At that point, your child can use the UGMA or UTMA funds to pay for college; however, it should be noted they can also use the money to pay for anything else. These accounts are not limited to only college expenses. It's also important to know that schools view this type of account differently(Less favorably for your family) than other accounts like a 529 for purposes of financial aid eligibility.
Savings Bonds
Savings bonds can be purchased through a bank to hold your college savings. Some savings bonds carry tax benefits when redeemed for higher education use. Savings bonds carry limits on how much you can purchase so some savers looking to put away larger amounts will have little flexibility here. Savings bonds also carry the added challenge of low interest rates. In return for the security you get you'll have a tough time earning enough interest to match the cost of inflation associated with higher education.
Roth IRA
A Roth Individual Retirement Account (IRA) is another account some families use to save for college. This is an account in a parent's name and is intended to be used for the parent's retirement. There is, however, an exception to the rules that allows you to remove money from a Roth IRA for a child's education expenses. Education is not the intended purpose for this type of account and this strategy has drawbacks. First, withdrawals for college are an exception to the rules. That means the IRS will assume you are on the hook for penalties unless you prove otherwise. The burden of proof is on you. Second, using money from a retirement account means you are depleting money intended for you and your spouse's future retirement! Exercise caution before thinking about using a Roth for education funding.
Brokerage Account in Parents' Name
Some families want to save for college, but want to retain the flexibility to spend money on something besides college if they choose. A brokerage account, held in one name or jointly, can serve that purpose. Because this is not a education-dedicated account, you'll receive no preferential tax treatment. This means any income like dividends or gains on an investment when you sell (capital gain) will be reported on your taxes. This tradeoff is worth it for many families who don't want to restrict what savings can be used for in the future.
Getting Started
Some families feel discouraged when they see the cost of a 4 year degree in relation to what they can afford to save. Saving is important but it's one component of paying for school. Tuition reimbursement, programs like Upromise, scholarships and more can work in tandem with your family's savings to put your future graduate on a path the minimizes or avoids student loans.
Free e-Book: 10 Ways to Pay for College as a Family
We help Christian families on their journey to financial freedom. If you would like more posts from us on how to balance what's truly important with your finances, please sign up for our free newsletter. If you’d like to hear more about how Intrepid Eagle Finance helps families manage their financial lives, click here to learn more and schedule a free consultation.