Explore college savings plans
What’s your best college savings strategy? To answer that question, you and your advisor need to take a look at your overall financial plan. How do college savings fit in with your other financial priorities, such as saving for retirement or moving to a new home? When you’ve determined what slice of your finances college savings can occupy, you can start actively saving, most likely in one of the following tax-advantaged plans.
Investments in 529 plan accounts grow tax-deferred and can be tax-free if used for the qualified education expenses of the account's beneficiary.
There are no funding restrictions based on income or age. In addition, there is no time limit as to when the investments must be used.
A 529 plan contribution is considered a completed gift to the account's beneficiary. Therefore, an account owner's contributions are generally considered to be removed from their estate, yet the account owner retains control of them.
In addition to ownership and control of the account's investments, a 529 account owner has the right to change the account's beneficiary and designate or change the account's successor account owner. A successor account owner assumes ownership of the account in the event of the death of the account owner.
Many states offer state tax deductions or credits for 529 plan contributions.
Qualified education expenses include post-secondary tuition, room and board, books, and computer expenses. Also included are K-12 tuition costs of up to $10,000 annually and payments for student loans of up to $10,000 (lifetime).
It’s also important to note that the earnings portion of withdrawals that are not used for qualified education expenses may be subject to ordinary income tax plus a 10% penalty.
Tax-deferred savings plans sponsored and administered by state agencies
Coverdell Education Savings Accounts (ESAs)
A Coverdell ESA is similar to a 529 plan in that it shares a number of benefits:
- Contributions to a Coverdell ESA grow tax-free until distributed to pay qualified educational expenses.
- Distributions are not taxed as long as the amount withdrawn is not more than the educational expenses paid at the eligible school.
- Distributions can be used for elementary and secondary (grades K-12) qualified educational expenses at eligible schools and college costs
A Coverdell ESA may not be the right choice for everyone.
Contributions are limited to $2,000 per child, per year and an ESA has income restrictions. The ability to contribute phases out for incomes between $95,000 and $110,000 (single filers) and between $190,000 and $220,000 (married filing jointly). Also, If withdrawals are not used for qualified education expenses, the earnings may be subject to income tax plus a 10% penalty.
Another tax-advantaged way to save for a child’s education expenses
Uniform Transfer to Minors Act (UTMA) accounts
Almost all states have UTMA laws, which allow a minor to own securities, investments and other property in a custodial account. You can use UTMA accounts to set aside money for a child’s future use or education expenses without setting up a trust.
UTMAs are custodial accounts that hold and preserve assets for the benefit of a minor until they reach the age of majority, usually 18 or 21, depending on the state. Assets in the account are overseen by a custodian (usually a parent) who has a duty to manage the assets prudently until the minor reaches the age of majority.
Consult with your advisor regarding additional features available through 529 plans, Coverdell plans as well as custodial accounts to determine the best option for you based on your goals.
Keep in mind, contributions to an UTMA are irrevocable, meaning you can’t undo them. Also, once the child reaches the age of majority, they have the ability to use the money however they see fit.
Custodial accounts that hold and preserve assets for the benefit of a minor