Planning for College: Tax-Advantaged Options for Saving for an Education
It’s important to start a college fund as soon as possible, because next to buying a home, a college education might be the biggest purchase you ever make, but where should you put your money? There are several college savings options, and it’s smart to consider tax-advantaged strategies whenever possible. Here are some options.
529 plans are one of the most popular tax-advantaged college savings options (they can also be used to pay K-12 expenses). 529 plans include both college savings plans and prepaid tuition plans, though college savings plans are far more popular. With either type of plan, your contributions grow tax deferred and withdrawals are tax free at the federal level if the money is used for qualified education expenses. States may also offer their own tax advantages. (For withdrawals not used for qualified education expenses, earnings are subject to income tax and a 10% federal penalty.)
A college savings plan is an individual investment account that lets you direct your contributions to one or more of the plan’s investment portfolios. With a prepaid tuition plan, you purchase tuition credits at today’s prices for use at specific colleges in the future. With either type of plan, participation isn’t restricted by income level and lifetime contribution limits are high, typically $300,000 and up (limits vary by state).
A Coverdell education savings account (ESA) is a tax-advantaged education savings vehicle that lets you contribute up to $2,000 per year for a beneficiary’s K-12 or college expenses. Your contributions grow tax deferred and earnings are tax free at the federal level if the money is used for qualified education expenses. You have complete control over the investments you hold in the account, but there are income restrictions on who can participate, and the $2,000 annual contribution limit isn’t likely to put much of a dent in college expenses.
Custodial account (UTMA/UGMA)
A custodial account allows a minor to hold investment assets in his or her own name with an adult as custodian. All contributions to the account are irrevocable gifts to your child, and assets in the account can be used to pay for college. When your child turns 18 or 21 (depending on state law), he or she will gain control of the account. Earnings and capital gains generated by the account are taxed to your child each year under the kiddie tax rules.
Though technically not a college savings option, some parents use Roth IRAs to save and pay for college. Contributions to a Roth IRA can be withdrawn at any time and are always tax free. For parents age 59½ and older, a withdrawal of earnings is also tax free if the account has been open for at least five years. For parents younger than 59½, a withdrawal of earnings — typically subject to income tax and a 10% premature distribution penalty — is spared the 10% penalty if the withdrawal is used to pay for a child’s college expenses.
College Savings Tip provided by RBFCU Investments Group: Even though college costs are high, don’t worry about saving 100% of the total. Many families save only a portion of the projected costs — a good rule of thumb is 50% — and then use this as a "down payment" on the college tab, similar to the down payment on a home.
How much college is projected to cost in the future
This chart can give you an idea of what future costs might be, based on the most recent cost data and an average annual college inflation rate of 5%. (Source: College Board, Trends in College Pricing 2017)
RBFCU Investments Group LLC is a wholly-owned subsidiary of RBFCU Services LLC. RBFCU Services LLC is affiliated with Randolph-Brooks Federal Credit Union (RBFCU). Securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA / SIPC, a registered broker/dealer and investment advisor. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution. FR-2104157.1-0418-0520
Article prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018; February 07, 2018
Illustration prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018; February 07, 2018