As the cost of higher education continues to rise, many parents and future students are confronted with the challenge of planning for this significant financial responsibility. Some students may receive support in the form of grants or scholarships, but these don’t always cover the full cost of a college education. Student loan debt can take years to erase and may make it harder to reach your financial goals.
Thankfully, there are a number of investment accounts that can make it easier to save for education expenses. Let’s discuss a few of the options that may be worth considering.
529 Savings Plan
The predominant college savings vehicle is the 529 savings plan, and it’s available everywhere across the US in one form or another. These plans are state-sponsored and can be categorized as either education savings plans or prepaid tuition plans, with the primary difference between the two being how their distributions can be allocated.
Anyone – parents, grandparents, extended relatives, friends, and even your child themself – can open and make contributions to this type of plan. Contribution limits differ from state to state.
529 Education Savings Plan
The standard type of 529 plan, an education savings account functions a lot like other tax-advantaged investment accounts in that it provides incentives that make it easier to save towards your goals – school, in this case. Contributions occur on an after-tax basis and funds in the account can be invested tax-free. No income taxes are due upon withdrawal as long as the money is spent on qualifying education expenses.
You can withdraw from a 529 education savings account to pay for qualifying education expenses starting from the time the beneficiary starts kindergarten on through their college years. If your child goes to a private elementary or high school, your withdrawals can also be used to help pay for this tuition. However, the IRS only allows up to $10k per year to be spent from this account between the years of kindergarten and 12th grade.
If your child doesn’t end up going to college, you can change the beneficiary on the account to another eligible beneficiary or convert your 529 to a Roth IRA. Taking non-qualified distributions from your 529 may result in having to pay income taxes on the withdrawal plus a 10% penalty.
529 Prepaid Tuition Plan
The prepaid tuition plan is designed to help students pay for public, in-state college by allowing them to pay some or all of the tuition costs ahead of time. Your account contributions are invested and guaranteed to grow at the same rate as college tuition costs, ensuring that the contents of the account scale to fit your tuition needs.
In comparison to the education savings plan, you’re more limited when it comes to deploying a prepaid tuition plan’s funds. The withdrawals from this account can only be used for college tuition and fees – they cannot be used for room and board or other expenses commonly associated with university. Additionally, prepaid tuition plans are only available in certain states.
Generally speaking, prepaid tuition plans offer a simpler and less risky alternative to the standard 529 education savings plan, albeit with less flexibility. If your child’s college plans change, you may be able to convert the account into one that helps cover private or out-of-state tuition, but there’s no guarantee that your prepaid plan will cover all of the new tuition costs.
Roth IRA
Although Roth IRAs are most frequently used to save for retirement, they can also be used to pay for qualified educational expenses. No additional penalty is assessed on these withdrawals, but you’ll still have to pay income taxes if you make any prior to retirement age. This tradeoff may be worth considering for parents because of the simplicity that comes with managing fewer accounts. Any excess funds that aren’t ultimately used for college can remain invested within the account for retirement, so you can save for both goals simultaneously.
Custodial UGMA and UTMA Accounts
The Uniform Gift to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA) offer two custodial savings accounts that can be used to save for your child’s education. Contributions to these accounts are made post-tax, and while there is no limit to the amount you can contribute to these accounts, you will have to pay gift taxes on contributions that exceed $17,000 per year. Unlike the 529 savings plan, the funds in these accounts are not limited to qualified education expenses; they can be used for anything.
Choosing the Right Plan
When saving for your child’s education, there are many plans for you to choose from that afford you the potential to grow your contributions over time. As with your other investments, time and discipline are key to achieving your long-term goals. If you could use help deciding which plan best suits your family’s needs, reach out to your financial advisor.
Best,
Robert (Rory) J. O’Hara III, CFP®, CRPC®
Founder I Senior Managing Partner
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
A 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. Every state offers at least one 529 plan. Before buying a 529 plan, you should inquire about the particular plan and its fees and expenses. You should also consider that certain states offer tax benefits and fee savings to in-state residents. Whether a state tax deduction and/or application fee savings are available depends on your state of residence. For tax advice, consult your tax professional. Non-qualifying distribution earnings are taxable and subject to a 10% tax penalty.
