College Savings: Understanding Your Options

pixabay - schoolFor most parents, paying for their children’s college education will be one of their greatest financial challenges. According to “Business Insider” future college costs are expected to inflate 5% per year. A current student will likely pay $76,979 for a four-year public college education but in eighteen years that cost is expected to surge to $185,259.

As you review possible strategies you need to carefully consider some of the following questions:

  • Is there flexibility in how & when the funds may be used?
  • Is a parent or child the account owner and how will this affect potential financial aid?
  • Are there contribution limits each year and for the life of the account?
  • Is the priority potential tax savings or diversified investment options?

To reduce the burden of student loans for their children, parents can start saving early and investing wisely with available strategies such as 529 Plans, Coverdell & Custodial Accounts, Roth IRA’s and/or non-qualified Brokerage Accounts.

529 Plan
529 plans come in two options – prepaid tuition plans and college saving plans. Both allow tax deferral on account earnings and earnings withdrawn for qualified higher education expenses. Accounts are typically owned by the parent(s).

529 Prepaid Tuition Plans
Prepaid tuition plans offer protection against college tuition increases by letting parents buy future tuition credits at today’s prices. Since prepaid tuition plans are operated by state governments, projected tuition is generally based on in-state public college tuition rates.

529 College Saving Plans
College savings plans, unlike prepaid plans, do allow the account owners to deduct some of the contributions on their tax return and choose the investment options offered under their particular plan. This plan offers parents the potential to earn returns above the yearly tuition inflation rate that the Prepaid Tuition Plan offers. The 529 College Saving Plan may, however, involve greater risks based on the investments used and the time available to grow the accounts before monies are used.

Coverdell Education Savings Account (ESA)
Under an ESA, parents and other contributors can make non-deductible contributions of up to $2,000 per child per year. Investments in an ESA potentially grow tax free as long as withdrawals are used to pay for qualified college costs and/or expenses for grades K-12.

Custodial Account (UGMA & UTMA)
Custodial accounts do not provide the potential to defer or escape taxes on investment gains. The first $1,000 of earnings remain tax free; the next $1,000 is taxed at the child’s rate. Any earnings above that are taxed at the parent’s rate until the child reaches age 24. Custodial accounts are considered an asset of the child which can significantly reduce financial aid. They also offer flexibility in how the money is used since withdrawals are not restricted to educational expenditures but can be spent in any way that benefits the minor.

Roth IRA Account
Roth IRA Accounts allow the owner of the account to take out up to 100% of the principal paid into the account after 5 years of the account being open. A primary appeal to this strategy is that money can continue to accumulate tax free if the student decides not to attend college or there is money left in the account after paying college expenses. The owner of the account has complete freedom to choose investment options. Annual contributions are limited based on age of the account owner and earnings cannot be withdrawn until owner reaches age 59 ½ without being assessed taxes and penalties.

Non-Qualified Brokerage Account
The non-qualified brokerage account has no limits to how much can be contributed annually into the account, no restrictions on investment options or what the contributions and earnings can be used for. Earnings are potentially taxable.

Make Educated Decisions
College investing programs come in many shapes and sizes today. As a Holistic Independent Advisor, I can offer insight and guidance to help lead you through the decision process. Contact me and together we can choose the right College Savings Plan that best fits your needs and tolerance for risk.