It’s never too early, or too late, to start saving for college. Scholarships and financial aid are an important part of the puzzle for covering college costs. But family savings plays a huge role.
Whether your child is in diapers or a high schooler, there are tax advantaged ways you can start saving for college today. There are easy programs you can use (that take a few minutes to sign up for online) where you can get high rates of interest and tax benefits for every cent you set aside.
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What is a college savings account?
A college savings plan allows a family to start saving money for future plans even from an early age. Education expenses are skyrocketing, financial aid can be difficult to get and other savings accounts may fall short without providing any real advantages. To ensure that a college education is possible, most parents and grandparents know that they have to look at savings plans from birth.
There are dozens of factors that will influence the decision on which type of college fund a family will choose including the tax advantages, the investment objectives, and the income limits. It is highly advised to seek the advice of a financial planner no matter how you plan to save money for higher education.
The most common education savings plans include 529 plans, Roth IRAs, Custodial Accounts, and Coverdell ESAs.
529 Savings Plans
The 529 Plans are administered by the states themselves and have a number of tax advantages that make them a favorite way to save for a kid’s college education. Many can be invested in from other states which makes them more flexible.
Funds can go towards tuition (at a public or private college) and related qualified expenses like text books, lab fees, or room and board.
There are 2 types of these accounts. The prepaid tuition plans allow you to buy credits towards tuition at specific schools at the rates being charged presently. These types of plans are available in 10 states at this time.
The other type is a savings-based account which has the advantage of being far more flexible and more common. There are multiple ways to invest in this type of 529 plan. Anyone can contribute to these funds including aunts and uncles, grandparents, and others.
These plans are:
- Money is also tax-free at withdrawal if being used for qualified education expenses. Different plans may have different types of expenses that are considered qualified.
- Remain in the control of the account holder regardless of the age of the stated beneficiary.
- Has a limit on how much can be used for student loan repayment.
The Roth IRA or “Individual retirement account” is typically thought of as retirement savings only. While that was how they are typically used and their original intention, as the cost of college and related expenses grew, people started looking for new ways to pay.
These plans are offered as savings and investment tools by brokerage firms, banks, and investment companies. They can be complex and difficult to understand for some people so a meeting with a financial advisor is a good idea to get some guidance in maximizing savings and minimizing risks.
The Roth IRA is less restrictive than other types of investment accounts with some tax advantages during funding and at the time of withdrawal if guidelines are met. There are strict, income-driven restrictions on how much can be contributed to these accounts per year.
Like the other plans, the custodial accounts are a type of savings account but this one does not have the tax advantages. As an investment account, there are 2 types with one allowing a wider range of investment options than the other. Because of the number of restrictions involved, these savings plans are better used as a supplementary plan to other education savings plans. The funds from these accounts can be used to pay for anything disqualified by the 529 plan.
One of the key differences between these accounts is ownership. With most, the person who started the savings plan retains ownership and control until they assign it to someone else. Custodial accounts typically become the property of the beneficiary once they have reached the legal age as determined by the state that they live in.
Coverdell ESA or Education Savings Accounts is an example of a custodial account. The named beneficiary has to be a minor at the time the account is created. There are some tax advantages to these accounts but there are also contribution and income limits that must also be considered.
Is a 529 plan better than a savings account?
If the goal is to pay for college, the 529 plan is way better. In addition to tax savings, your investments can increase the amount in the account dramatically.
The average savings account, on the other hand, earns .06% interest per year and does not have any advantages in terms of tax savings when the funds are withdrawn.
What is the difference between a 529 and an ESA?
The major difference between these 2 college savings plans is in the ownership. With a 529 plan, the ownership never changes. With an ESA, the account can be turned over to the beneficiary at a certain age. That age varies from state to state.
What happens to a 529 plan if your child doesn’t go to college?
There are a lot of things that can be done with the 529 plan funds outside of qualifying college expenses.
- They can be used for other types of education as long as the school qualifies under the state’s plan. This could include trade schools or apprenticeships in a skilled labor career.
- The funds can be transferred to another family member without any changes to the fund.
- The money can be used in another way however there will be a tax penalty of 10% on the amount withdrawn.
How do I start a college savings account for my child?
If you can speak with a qualified financial planner, that would be the best place to start. Regardless, it is important to have a realistic goal in mind and then to do the research into the various plans. Once you choose a plan that works for your current budget (it won’t help to have big dreams for the future if you can’t pay the minimum deposit needs right now), make it an iron-clad part of your family budget.
Can I open a 529 plan for my godchild or grandchild?
Yes! You absolutely can do that. One of the biggest appeals of the 529 plan is the ability to allow anyone to create or contribute to one, no matter where they are as long as they are a family member.
You will need some basic information about the child to get started. You can add money to the fund without having to pay taxes on it and once the child is of college age, the funds can be withdrawn to help them attend college or seek other forms of higher education.
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