4 Ways to Save
Parenting… for many people, it’s the toughest job they’ll ever have. And once you are past potty training, toddler tantrums and teaching them to drive, one of the greatest challenges you will face is paying for your child’s college education. Regardless of whether you fund all or just a portion of it, the smartest thing you can do is to start saving now.
When it comes to education funding, you have many choices. Here are four ways to start saving for their future.
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1. 529 College Savings Plan
This plan is an investment account, like some IRAs, that lets you make contributions into a managed portfolio consisting of mutual funds and other investments. Your earnings will grow tax free and the funds can be used for tuition and related education costs, including room and board, at eligible colleges and universities. Funds can usually be shared; if one of your children doesn’t go on to college, the money can be used by another. Since the value of your account depends on market performance, a 529 works best when funds can grow over a long period of time.
2. 529 Prepaid Tuition Plan
These plans, typically managed by public universities or by states themselves, let you pre-pay for in-state tuition at current prices. You typically purchase units, and the value of those units is guaranteed by the state or sponsoring institution to keep pace with the cost of college tuition. Plans vary; with some, funds can only be used for tuition and fees while others allow any qualified education expense. Individual plans also vary on whether funds can be transferred to another child. Funds might be usable at private and out-of-state institutions, although the value will differ.
3. Coverdell Education Savings Account (ESA)
Commonly known as ‘education savings accounts’ or ‘education IRAs,’ a Coverdell ESA is an investment account that provides tax-free investment growth and withdrawals for qualified education expenses, including college, elementary, and high school. The Coverdell has lower withdrawal limits than the 529 and a contribution limit of $2,000 per child. Your ability to contribute to an ESA is limited by your income, which must be less than $110,000/$220,000 depending on whether you file single/jointly. As with a 529, you can switch the beneficiary from one child to another.
4. Custodial Account
These types of trust accounts don’t have tax benefits for educational purposes. UTMA and UGMA (Uniform Transfer/Gift to Minors Act) accounts also differ from 529 and Coverdell accounts in that they are held in your child’s name but are controlled by you or another custodian. You have control over the money until your child reaches age 18 or 21 (depending on the state), but then your child can use the money however they choose—for college or anything else. Custodial accounts are considered a student asset, and count against them when calculating financial aid, so they make most sense if your child is unlikely to qualify.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.