Saving for college: What to know about your options
Understand the different saving vehicles to help stay ahead of rising education expenses and reach your goals.
After you know how much to set aside toward achieving your college saving goals, your next step is exploring options to help make that possible based on your priorities, long-term goals and tax situation.
Given the variety of choices available, an Ameriprise financial advisor will help you develop tax-advantaged strategies that make sense for you and your other long-term goals. Here’s what to consider as you choose the right saving vehicle for your situation.
In this article:
- Start with your savings goal
- Consider the pros and cons of different tax-advantaged savings options
- Implement your plan
- Questions to ask an Ameriprise financial advisor
Estimating how much to save gives you a target to strive for and helps you determine which saving vehicle best fits your goals. It doesn’t have to be exact. You can always change the goal as your child’s interests and aspirations change. Consider using our college savings calculator to determine how much you may need to start saving.
One of the popular options to save for college is a 529 plan, which is a tax-advantaged account primarily intended for higher education expenses.
A 529 plan allows an individual to contribute after-tax money into an investment account on behalf of a designated beneficiary. Almost all U.S. states offer a 529 plan, and investors are generally free to shop around for a plan that works for them, regardless of their residency status.
Here are some pros and cons:
Bottom line: A 529 plan can be a powerful college saving vehicle. There are many reasons why these are a popular account for education goals, but it’s necessary to understand how it works before you can take full advantage of it.
Formerly known as an Education IRA, a Coverdell Education Savings Account (ESA) is a college savings option similar to a 529 plan in that contributions grow tax-deferred — but come with more limitations.
Bottom line: A Coverdell ESA can be a useful vehicle, but it offers less flexibility and savings potential than a 529.
With a cash-value life insurance policy, a portion of your premiums goes toward a death benefit and another portion is allocated into a cash-value account. When properly structured, you can take out an income tax-free loan against your cash value to pay for school.
Bottom line: Permanent life insurance can offer investors an alternative way to pay for their student’s educational expenses. But college savings shouldn’t be the primary goal when deciding whether to open a policy.
In addition to the above vehicles, below are a few other college saving options. Please note: These options don’t have the same tax advantages as the accounts mentioned above and generally aren’t as optimal for college saving goals.
The biggest benefit of using a traditional investment account to fund your child’s college is the flexibility and freedom it offers. Unlike 529 plans, these accounts don’t have limitations on how you spend your assets, what funds you can invest in or how much you can contribute.
However, you won’t receive any of the tax advantages if you were to use a 529 plan or Coverdell ESA. Instead, after-tax dollars fund brokerage accounts, and withdrawals are taxed as capital gains.
Bottom line: Using traditional brokerage accounts to save for your child’s education is not a tax-efficient method. However, these accounts offer more flexibility than tax-advantaged college savings options. If you are willing to forgo potential tax savings in favor of more flexibility with their college funds, then a brokerage account may be a good option.
While traditional savings accounts and certificates of deposits (CDs) may keep your money out of the market and can be lower risk, their earning potential doesn’t make them an ideal long-term college savings option for parents seeking to pay big expenses, such as tuition. Generally, the rate of return on these types of accounts don’t keep pace with inflation or rising college expenses.
In many cases, these accounts are better used to build a cash reserve and save for less significant college costs that have a shorter time horizon and don’t count as a qualified higher education expense. For example, if your child is a year out from college and you want to help furnish their dormitory, a savings account is a smart place to accumulate funds for that short-term goal.
Bottom line: Savings accounts and CDs are not long-term solutions for saving for big college expenses, such as tuition and room and board. However, as you get closer to your student’s college years, savings accounts and CDs can be helpful vehicles to keep your money liquid for smaller expenses.
Before you redirect retirement assets to your child’s college costs, consider the implications. If you withdraw from a 401(k) or an IRA to fund your child’s college costs, you may be subject to additional costs, such as income tax or early withdrawal fees, and you are also impacting your future retirement income. Overall, using a retirement account is generally not advisable to save for a child’s college expenses.
Bottom line: When it comes to balancing retirement and saving for college, retirement should be your priority. Remember: You can’t get a loan to fund your retirement years.
Once you’ve settled on the college savings options that work for you, it’s time to open your preferred account and start saving to help reach your education goal(s).
When you’re ready to reach out to an Ameriprise financial advisor for a complimentary initial consultation, consider bringing these questions to your meeting.
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An Ameriprise financial advisor can help weigh the pros and cons of various college savings options and make a recommendation aligned with your other goals and financial situation.
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Background and qualification information is available at FINRA's BrokerCheck website.
This information is being provided only as a general source of information and is not a solicitation to buy or sell any securities, accounts or strategies mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as a recommendation or advice designed to meet the particular needs of an individual investor. Please seek the advice of a financial advisor regarding your particular financial situation.
Clients contributing to a 529 Plan offered by a state in which they are not a resident, should consider, before investing, whether their, or their designated beneficiary(s) home state offers any state tax or other state benefits such as financial aid, scholarship funds or protection from creditors that are only available for investments in such state’s qualified tuition program.
The earnings portion of money withdrawn from a 529 plan that is not spent on eligible expenses will be subject to income tax, an additional 10% federal tax penalty, and the possibility of a recapture of any state tax deductions or credits taken.
Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
Ameriprise Financial cannot guarantee future financial results.
The initial consultation provides an overview of financial planning concepts. You will not receive written analysis and/or recommendations.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
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