Having a child comes with many added expenses, but does your budget include saving for your child’s future college expenses?
Funding college may not feel like a top priority for a new baby (especially if your child hasn’t even started kindergarten yet!), but if you can afford to start saving some dollars each month towards the expense, even if it’s small amount, the benefit in the future will be much greater. Some kids may look to pay for college on their own, but many parents want to help where they can.
While future education costs are difficult to predict, we know the cost to attend college has been increasing at a rapid rate. The key is to start as early as possible and use time and compounding interest to your advantage, especially if you are sending multiple kids to college.
Aside from a savings account at a bank, there are various investment accounts you can use to save for education. Below are three of the most popular accounts, which each have their own unique pros and cons:
1. 529 college savings plan
- A 529 plan, which allows you to invest after-tax dollars, provides tax-free growth when the funds are used for a qualified education expense. Qualified education expenses include tuition, room and board, books, computers and related equipment.
- 529 plans can be used not only for four-year public and private colleges in the United State but also a number of international schools.
- If your student decides to take an alternate route other than the four-year college route, there are a few non-traditional schools that are eligible, including the Golf Academy of America; the Le Cordon Bleu College of Culinary Arts; the commercial diving program CDA Technical Institute in Jacksonville, Florida; and the Chicago Theological Seminary.
- 529 plans have no income limits for contributing.
- Over 30 states offer a tax-deduction for contributing to a 529 account; however tax-deductions are typically available only if funds are deposited in to the state-sponsored program. Do your research prior to making contributions.
- A donor can contribute up to $15,000 per year, per child, without gift tax consequences. Or, there is the option to pre-fund the 529 with up to five years of contributions ($75,000 total), this is referred to as “super funding.” The number of donors that can contribute are unlimited.
- 529 accounts typically have a parent or grandparent listed as the owner, with the child as the beneficiary, meaning the owner of the account maintains control over the assets.
- If the beneficiary decides not to go to college, the beneficiary on the account can be easily changed to another qualified family member. Qualified family members include children, parents, spouses, siblings, first cousins, nieces and nephews, and aunts and uncles.
- If the funds are not used for a qualified education expenses, the earnings portion of the distribution is subject to income tax and a 10% penalty.
2. Uniform Transfer to Minors Act (UTMA) / Uniform Gift to Minors Act (UGMA)
- Gives you flexibility in the use of funds if the beneficiary ultimately does not wish to attend college (aka there are no penalties for non-qualified expenses, like the 529 plan).
- Like the 529 plan, a donor can contribute up to $15,000 per year without any gift tax consequences. The number of donors allowed to contribute are unlimited.
- UTMAs and UGMAs accounts are held in the child’s name, but the account has an assigned custodian until the child reaches their age of majority (typically age 18, but it varies by state). Once the account is turned over to the child at age of majority, the custodian loses control of the assets, meaning the child could spend the funds contrary to their parents’ wishes.
- UTMAs and UGMAs have the potential to adversely affect the child’s qualifications for financial aid, since the assets belong to the child.
3. Coverdell Education Savings Accounts (ESA)
- Coverdell ESAs are accounts that offer tax-free growth on assets used for qualified education expenses.
- Funds can be used for qualified elementary, high school and college expenses.
- Contributions are limited to $2,000 per beneficiary, per year. Meaning if grandparents and parents are both contributing to the child’s Coverdell ESA account, the combined contributions cannot exceed $2,000.
- There are income limits for donors.
- Like the 529, the earnings portion of any non-qualified withdrawals from the account will be subject to income tax as well as a 10% penalty tax.
- Funds must be withdrawn by the time the beneficiary turns 30 years old.
Making it easier to save
When it comes to saving in each of these accounts, think outside the box. In addition to monthly savings, you could put birthday money or allowance money into the education savings account, allowing your child to “have some skin in the game” while also instilling smart money habits — a win-win!
Are you ready to start planning for your family’s financial future? Let us help.
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