It’s back-to-school season, and whether your child is starting kindergarten or their senior year, paying for your child’s higher education is always a concern. With the cost of college tuition rising every year, it's important to save for education as early as possible. The average cost of tuition and fees at a private four-year college is now $38,185 per year and $10,388 per year at a public four-year college for in-state students. That's a big investment, so it's important to start saving early to maximize your child's education savings.
There are a number of ways to save for your child's education, including 529 plans, Coverdell accounts, and UTMA/UGMA accounts. However, the best way to maximize your child's education savings is by doing some research and careful planning.
Aside from proper budgeting and reallocating costs, there are many ways to use investments to save for your child’s education. Let’s have a look at some different methods you can use to maximize your savings
A 529 plan is a tax-advantaged savings plan that’s meant to be used for saving funds for future education costs. Contributions made to a 529 plan are not subject to federal income tax and may be eligible for state tax deductions or credits as well.
A Coverdell Education Savings Account (ESA) is another tax-advantaged account that can be used to save for a child’s education expenses. Contributions to a Coverdell ESA are not subject to federal income tax and can grow tax-deferred until withdrawn. Withdrawals from a Coverdell ESA are not subject to federal income tax as long as they are used for qualified education expenses.
Both traditional and Roth Individual Retirement Accounts (IRAs) can be used to save for education expenses. Contributions made to a traditional IRA are typically deductible from income taxes, while contributions made to a Roth IRA are not deductible but withdrawals are typically not taxed if taken after a certain age and the account has been open at least five years.
US Savings Bonds are low-risk investments that can be used to finance education expenses. Interest on US Savings Bonds is exempt from state and local taxes, and bonds can be cashed in at any time without penalty.
A taxable investment account can be used to save for any type of goal, including education expenses. While there are no special tax advantages associated with this type of account, it does offer flexibility in terms of how funds can be invested and withdrawn.
Cash value life insurance policies accrue cash value over time that can be accessed through policy loans or withdrawals (subject to certain rules and regulations). The cash value of life insurance policies can be an excellent source of funding for education expenses since it grows tax-deferred and typically isn’t subject to taxation when withdrawn.
UGMA/UTMA accounts allow you to gift money or property to a child without triggering gift taxes, and the child can use the money for any purpose once they reach adulthood (18 or 21, depending on the state). However, the earnings on these accounts are taxed at the child’s rate, which is usually lower than the parents’ rate, so there may be some tax advantage.
A custodial brokerage account is similar to a UGMA/UTMA account, but with more investment options. Like a UGMA/UTMA account, the money in the custodial brokerage account belongs to the child and the parent controls how it is invested until the child reaches adulthood. Still, there may be more restrictions on how the money can be used once the child reaches adulthood since it must be used for educational or other specified purposes only.
Choosing the right savings plan for your child’s education entails more than just picking the option with the highest returns. There are a few factors and conditions to take into consideration that might make one saving account favorable over another.
Consider a 529 plan, as they have tax advantages and do not count as assets when determining financial aid eligibility.
If the money will be used for things such as rent or transport, a 529 plan may not be the best option, as there may be restrictions on how the funds can be used. Instead, consider a Coverdell ESA, as it can be used for expenses such as room and board, books, and transport.
Some savings plans have limits on contributions, so if you are planning to save a large amount of money, you should make sure that the plan you choose allows for this. For example, the Coverdell ESA has a contribution limit of $2,000 per year.
Think about whether or not you want the money to be accessible immediately or if you are willing to wait for it to grow over time. For example, a custodial account is an immediate-access account, while a 529 account typically has restrictions on withdrawals.
It’s important to take taxes and fees into consideration. For example, contributions to a 529 account are tax deductible in some states, while Coverdell ESA contributions aren’t taxed. Some savings plans have fees associated with them, so compare fees and tax implications of different accounts before deciding which to open.
Of course, you can use more than one type of savings account or investment to save for your child’s education. Some of the investments covered here just need an initial setup and can work to incur interest for years until your child is ready for college, resulting in a somewhat passive source of income.
Regardless of which plan you select, you want to be able to keep track of it over time to see how it's performing. Vyzer can help you gain a detailed overview of your college savings investments as well as any others so that you can see how your funds are performing all in one place.
