As a parent, I can imagine the pride felt when a child graduates from college. Not only does the student work hard to graduate, but the parents also work hard to make it happen, both emotionally and financially. Due to the economy, a lot of students are taking on student debt to pay for their college education. One thing is certain; many parents want to help reduce this burden on their children, if possible. Some options that parents are taking advantage of are scholarships, tuition plans, or even refinancing their home. If you’ve already looked into these options and want to create a college savings account, it’s important that you educate yourself about the different options available to help with the rising cost of higher education.
It almost seems like learning about the types of college savings accounts requires a college degree by itself. Section 529? Coverdell accounts? UGMA? UTMA? WHAT?!
There are many options available for those who wish to help pay for a child’s education – too many to cover in one article alone. This is why I’m including three of the most common college savings accounts. As you read this information, keep in mind that whenever you make a financial decision, it’s always wise to consult your financial advisor to help you find the best option for your unique situation.
UTMA/UGMA Custodial Accounts
These accounts are great for parents or grandparents who aren’t concerned if the funds go to the child even if the child doesn’t attend college. They are basically savings accounts that the child can access once they turn 18. Before the child turns 18, the custodian has access to the funds and can even use them, if necessary.
Some of the other advantages of UTMA/UGMA accounts are that because these accounts are under the child’s social security, parents or grandparents are not tax responsible for the gains that this account earns. Also, because of the “kiddie tax law,” some of the income generated by these types of accounts can go untaxed up to $850, and another $850 taxed at the child’s tax bracket. Anything above these limits is taxed at the parents’ tax rate. Also, there are many investment options allowed under these types of accounts, giving the owner flexibility. However, no high-risk investments are allowed.
A disadvantage is that since these types of college savings accounts are considered part of the child’s assets, when applying for financial aid, it could actually decrease the amount of financial aid the child can receive.
Section 529 Savings Plans
There are two types of Section 529 plans: savings and prepaid tuition plans. We’ll cover Section 529 savings plans in this article.
Section 529 savings plans are great for parents or grandparents who wish to save more than $2,000 a year, or are planning on saving large amounts towards college costs (either because they started saving late in the child’s life or because they plan on attending an expensive school). It’s also a great option for those who live in a state that offers a state income tax deduction for contributing to a Section 529 account.
Also, Section 529 savings plans offer tax-deferred and sometimes even tax-free withdrawals. So, you don’t have to pay taxes on the gains if the money is used for college education. They also allow the owner of the account to remain in control of the account or even close it, if they choose to do so.
A few of the disadvantages are that the funds in these accounts are not available for costs associated with K-12 education, the options of investments available are limited, and they may also affect financial aid eligibility.
Coverdell ESA (aka Education IRA)
Coverdell ESAs allow up to $2,000 per year in after-tax contributions and can be tax-deferred and tax-free when used for qualified educational expenses. One key difference is that if the beneficiary (child) doesn’t use it by the time he/she turns 30, the account can be transferred to another family member.
This account is great for families with several kids that want to attend college or have plans on attending private schools. Even though there is an income limit ($95,000 for single filers, $190,000 for married couples), they offer flexibility of investment options that other types of accounts don’t. One advantage is that Coverdell accounts are still considered part of the parents’ assets, so it doesn’t affect financial aid eligibility, unlike UTMA/UGMA accounts.
A disadvantage of a Coverdell ESA is that, unlike Section 529 accounts, contributions are not tax deductible. Also, the tax-free treatment of distributions depends on whether the funds are used for a qualified education expense. Learn more about what is considered a qualified expense and more about Coverdell ESAs at the IRS website.
We hope this information was a good start to your research in finding the right college savings plan for you. If you want to learn more about saving for college and other ways to avoid debt and build wealth, you can also check out Dave Ramsey’s article titled “The Seven Baby Steps.” It has some great information about creating a financial plan for you and your family.
Please share with us any savings tips that you’re using to help save for college!