A major component of financial planning is saving for higher education expenses. With many available options, it can be daunting to know where to start. The purpose of this blog is to help you better understand the unique differences of the various education savings vehicles.
According to Sallie Mae, general savings accounts held at a bank are the most often used funding vehicle for college. While utilizing a savings account for education expenses may seem like the easiest option, your savings may not go far enough when comparing the interest earned at most banks relative to the inflation rate of college expenses. For example, if your savings account earns 1% and annual college expenses are growing at 4%, your savings are not keeping up with rising costs.
Many do not know that there are savings vehicles that offer better growth opportunities and potential tax advantages. These are 529 Plans, Coverdell Education Savings Accounts, UTMA/UGMA accounts, and Roth IRAs.
The 529 is a tax-advantaged savings plan sponsored by every state and the District of Columbia. There are two types of 529 plans, Prepaid Tuition Plans and College Savings Plans:
A second education savings account is the Coverdell Education Savings Account (ESAs). These accounts are like 529 plans in that they also grow tax-deferred and withdrawals can be made tax-free for qualified education expenses. However, you are limited to a maximum annual contribution of $2,000 and if your adjusted gross income is more than $110,000 annually ($220,000 annually for those filing married filing jointly), you are unable to contribute.
Other options for education savings include UTMA/UGMA accounts. With an UTMA/UGMA account, assets are placed in the beneficiary’s name with you serving as custodian until they reach the age of majority in your state. Assets are subject to capital gains taxes and once the beneficiary reaches the age of majority, the assets transfer to their sole ownership to be used as the beneficiary wishes. This means that the assets you have saved may not be used exclusively or at all for higher education expenses.
Roth IRAs are also an option although as wealth managers, we would prefer those assets remain intact for retirement planning purposes. Since contributions to Roth IRAs are after-tax, withdrawals are made tax-free if you are older than 59 ½ which is a great benefit for retirement income and an inheritance to your heirs. However, the assets in a Roth IRA can be used for qualified education expenses without incurring the 10% penalty prior to reaching age 59 1/2, but the withdrawals may count as income when you file to FAFSA to determine financial aide eligibility.
The point in all of this is that there are several savings options for future college expenses. It is important to begin saving early and often. If you have questions or would like more information about your options, please give us a call.
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