3 Ways to Save for Your Child’s Education
Is college in your child’s future? Whether it’s just a couple of years away or your kids are still in daycare, saving for college is a huge commitment.
There are many different ways to save for college, from a standard savings account to savings bonds, and even prepaid tuition plans if you’re absolutely sure your child will attend college in your home state.
Three college savings plans that are worth knowing a little more about include the popular 529 plan, the lesser known uniform transfer to minor account, and a Roth IRA, which isn’t just for retirement.
First off, the 529 plan. This is the most commonly used, and for good reason. After-tax money funds the 529 plan, and the account balance then grows tax-free. Distributions are also tax-free if they’re used for qualified education expenses, which now also include K-12 – private or charter school expenses, for example.
One of the reasons that 529 plans are so popular is that parents keep control of the assets. Another reason these accounts are so valuable is that the child’s aunts or uncles, grandparents and others can contribute to the account, too. These make for great birthday and milestone gifts.
These plans do have downsides. For example, if you were to withdraw distributions for non-educational expenses, you would pay income tax and a ten percent penalty. This could become an issue if your child has all his or her college expenses covered, and there’s still money left over in the 529 account.
There are other options to handle this situation; as one example, you would simply change the beneficiary of the account to a younger sibling, niece or nephew, or grandchild. Another option? 529 plans can be used to pay for the beneficiary’s student loans, up to $10,000.
Custodial accounts allow a parent to save money for college or other expenses on behalf of their child. These are useful accounts when there’s an inheritance or other significant gifts that are for the sole benefit of the named beneficiary.
When saving for college, custodial accounts like the uniform transfer to minor (UTMA) account, are a little less popular because they can be somewhat less flexible than 529 plans. For the student, however, there are a lot of upsides to consider.
Parents fund UTMA accounts with after-tax contributions. Those contributions are then invested, and the student can use the earnings without any restrictions. Some examples of the ways that beneficiaries over 18 can use UTMA earnings include buying:
- A car
- A home
- School supplies or books
- UTMA earnings can also be used to fund the beneficiary’s own retirement.
There aren’t any contribution limits, and a small amount of contributions may be exempt from federal income tax.
The downsides? The parents lose control of the assets when the child or beneficiary turns 18. Gifts made to a UTMA are irrevocable and can only be used for the minor’s benefit.
That flexibility comes with another caveat: income taxes will be owed on growth inside the UTMA account. Most children just starting out their adult lives don’t have a tremendous amount of income, so their income tax associated with these accounts tends to be small. It is a consideration, though.
Also: gifts of more than $16,000 per year may trigger the gift tax and lifetime exclusion limits. Finally, colleges and universities tend to view UTMAs as the student’s assets, which can negatively impact financial aid.
Not just for retirement, Roth IRAs can be a valuable college savings tool for older children with part-time jobs.
If your child has a summer job or works part-time throughout the year, encourage him or her to invest at least some of the earnings into a Roth IRA. These accounts take after-tax contributions and from there, the account grows tax-free. Earnings will remain tax-deferred if left in the Roth IRA until age 59 1/2; however, there’s another provision for college students.
Roth IRAs can be used for education expenses, too. He or she would only pay tax on the growth and would not incur any early withdrawal penalties for eligible education expenses.
There would be more investment choices in a Roth IRA than in a 529 account, and the choice to keep the funds in the account for retirement is another major plus. Either the student or the parent could open a Roth IRA for this purpose; for parents, that would provide flexibility if their child either doesn’t go to college or gets a full scholarship. You’re still saving for retirement!
Depending on the situation, one of these college savings accounts may be better suited for your personal needs than another. Before putting your money toward any single investment vehicle, it’s a good idea to talk with a financial advisor to decide the best fit for your needs today and considerations for tomorrow.
Contact Adams Brown Wealth Consultants to find the best fit for your college savings goals.