One common financial goal for parents with kids is saving for their college education. This is a great way for parents to give their kids a boost through higher education with the hope of graduating with no or student loan debt. In this article we will cover the most common ways parents can save for their child’s higher education.
The most common way to save for college is a 529 Educational Savings Plan. A 529 plan allow parents, grandparents, guardians, or any relative to contribute towards the beneficiary’s education. One of the biggest benefits of this type of plan are the tax benefits. First, contributions (if made by the account owner) are eligible for a state tax deduction. Once in the account, the money is invested and grows tax-deferred until it is withdrawn. If the withdrawals are used for qualified educational expenses (tuition, fees, books, supplies, room and board, etc.) then they are tax-free! In other words, you get a tax benefit for putting money in (the state tax deduction), letting it grow (tax-deferred growth), and using it for education-related expenses (tax-free withdrawals). 529 plans also have a high contribution limits, no income limits for contributions, no age restrictions for contributions or withdrawals, and count as parental assets on the FAFSA. The 529 plan will pay for higher education at universities, graduate school, community college, technical or vocational school. Plus, if the original beneficiary doesn’t use all of the money in the account, it can be moved to another in-family beneficiary like a younger brother or sister.
Another way to save for college is a Coverdell Educational Savings Account. This type of plan has some similarities to 529 plans but also some key differences. A couple of the similarities are the ability to change beneficiaries to another family member and the account is counted as a parental assets on the FAFSA. Coverdell accounts and 529 plans both offer tax-free growth of the contributions and tax-free withdrawals for qualified expenses, however Coverdell accounts contributions are not tax-deductible. Overall, Coverdell accounts have more restrictions than 529 plans including contributions are limited to $2,000 per beneficiary per year, withdrawals can only be used for tuition and fees, contributions must be made before the beneficiary is 18 and must be used by the age of 30, and the ability to contribute is phased out for incomes between $190,000 – $220,000 (joint filers) and $95,000 – $110,000 (single)
The last way that we will cover is a UGMA/UTMA, which stands for Uniform Gift (or Transfer) to Minor Account. This type of plan differs greatly from 529 plans or Coverdell accounts. UGMA/UTMA accounts used to be more common, but they aren’t as widely used anymore. Within these accounts, earnings and gains are taxed to the minor and the first $1,100 of unearned income (dividends and interest) is tax exempt. The most important thing to know about UGMA/UTMA accounts is that once the beneficiary reaching the age of majority according to state law (usually 18-21), it is their account to do with as they please. Once they are of age, the funds could be used for their college education or for their new car. There aren’t any restrictions on how the money must be used other than it must be used for the benefit of the minor. UGMA/UTMA accounts offer the most flexibility when it comes to the amount of contributions, the maximum investment within the account, and the uses for the money but the parent gives up control of the account once their child reaches a certain age.
These accounts all offer different benefits for savings for your child’s college education. No matter what type of account you use, the biggest benefit by far is starting as early as possible. The earlier you start, the more time your money has a chance to grow.
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