With higher education tuition increasing at double-digit year-over-year percentages, an effective saving plan for your kid’s education is becoming much more important than before. An article details that education expenses have outpaced inflation by 28%. Most families will discover that their future higher education costs will be much more than they have saved for their kid’s education. This leaves many kids to be faced with obtaining financial aid to pay for a portion of their college education. This post explores the pros and cons of four common investment options when saving for college. This post will also explore why some of these options are better than others when considering a portion of your kid’s education may be funded by financial aid.
529 College Savings Plan
A 529 college savings plan is an investment option for college savings, and it allows just about anyone to save for college. There is a long list of benefits of a 529 college savings plan, but perhaps the most important is that your earnings grow tax-free if you use it for qualified education expenses. Additionally, the maximum amount you can contribute to a 529 plan can go as high as several hundred thousand dollars, depending on your State. For more on the contribution limits to a 529 savings plan, click HERE. If you do not use the funds for college, you can still withdraw your earnings, but you will have to pay taxes and a 10% penalty. The penalty will be waived if your child receives a scholarship, becomes disabled, or dies.
529 plans can typically be purchased through a broker or mutual fund company, but a disadvantage is that investment choices can sometimes be limited. Since qualifying for financial aid is based on a calculation that considers your kid’s assets, another big benefit of a 529 college savings plan is that the money in the plan is classified as a parent’s asset. Hence, less than 6% of the value counts against your kid’s financial aid eligibility.
For an earlier post on the basics of 529 plans, click HERE.
Uniform Gifts to Minors Act/Uniform Transfers to Minors Act
(UGMA/UTA Custodial Account): – The benefit of a UMGA/UTA Custodial Account is that there is no limit on the contributions, and it is easy to set up at most financial institutions. However, the limitations far outweigh the benefits. The first limitation of a UMGA/UTA Custodial Account is that these accounts offer very little tax advantage. If your child is under 14, only the first $800 of income is tax-free, the next $800 is taxed at your child’s tax rate, and after that, there is no tax benefit at all. The other big limitation is that the account must be set up in your child’s name. As a result, if your child needs financial aid, all assets will be reviewed at a 35% rate. Therefore, this type of account is not advisable for those who may need financial aid.
Coverdell Education Savings Account (CESA)
A Coverdell Education Savings Account is similar to a 529 college savings plan, and the main difference is that with a Coverdell Education Savings Account, you can only contribute $2000 per child. To qualify, your adjusted gross income must be less than $110,000 if single and less than $220,000 if married filing jointly. For more information on the limits and phase-outs, visit HERE. The account is classified as a parent’s asset, so less than 6% of the value counts against your kid’s financial aid eligibility.
In the end, parents should consider planning for college to be a highly important process. The above three alternatives can make this process much easier and financially sound.
If you need additional assistance, contact me directly if you are in or near the Metro-Nashville area. If you reside outside of Tennessee or prefer someone closer, seek out a qualified fee-only Registered Financial Consultant near you.
