College Savings Choices

Posted by: Joseph Kuo | December 3, 2021

How can you help cover your child’s future college costs? Saving early (and often) may be key for most families. Here are some college savings vehicles to consider.

529 College Savings Plans

Offered by states and some educational institutions, these plans allow you to save up to $15,000 per year for your child’s college costs without having to file an IRS gift tax return. A married couple can contribute up to $30,000 per year. However, an individual or couple’s annual contribution to a 529 plan cannot exceed the yearly gift tax exclusion set by the IRS. But you may be able to front-load a 529 plan with up to $75,000 in initial contributions per plan beneficiary—up to five years of gifts in one year—without triggering gift taxes. Funds in a 529 plan are considered parental assets for purposes of financial aid calculations.

Remember, a 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. That means that as long as the funds are used for education purposes, gains and withdrawals are not taxed. State tax treatment of 529 plans is only one factor to consider before committing to a savings plan; the fees and expenses associated with the particular plan should also be considered. Some states will also offer an additional state tax deduction on 529 plans.

Any earnings of a 529 plan not used for education will be subject to income tax and a 10% federal penalty tax. So when managing a 529, you should take care to not overfund the account. There are some ways to mitigate excess amounts though. If your child finds another means of funding (such as a scholarship or grants), you can withdraw the difference which is taxed as capital gains but will avoid the 10% penalty. You can also switch the beneficiary designation to another child in your family, or roll over the distributions into a different 529 plan established for the same without tax consequences.

Grandparents can also start a 529 plan or another college savings vehicle. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself, so if you’re going back to school to finish up a degree or get a second degree, the 529 can definitely be an option.

Coverdell Educational Savings Accounts

Single filers with modified adjusted gross incomes (MAGIs) of $95,000 or less and joint filers with MAGIs of $190,000 or less can pour up to $2,000 into these accounts annually. If your income is higher than these limits, the limits phase out apply above those MAGI levels. Money saved and invested in a Coverdell ESA can be used for K-12 education expenses as well as college fees, so it can be a good option if your kids are in private schools.

Contributions to Coverdell ESAs aren’t tax-deductible, but like a Roth IRA, the accounts enjoy tax-deferred growth and withdrawals are tax-free, as long as they are used for qualifying education expenses.³ Contributions may be made until the account beneficiary turns 18. The money must be withdrawn by the time the beneficiary turns 30, or taxes and penalties may occur.

UGMA/UTMA Accounts

The Uniform Gift to Minors Act (UGMA)  allows for financial assets such as stocks and mutual funds to be transferred to a child for college educational use. The Uniform Transfer Minors Act (UTMA) is an extension available in many states that expands the rules to include any transferable asset, including real estate. UGMA/UTMA account assets are considered to be belonging to the child for financial aid calculations, so they can be a favorable option if your child is applying for college financial aid using your financials.

These all-purpose savings and investment accounts take the form of a trust and are often used to save for college. When you put money in the trust, you are making an irrevocable gift to your child. You manage the trust assets until your child reaches adulthood (from ages 18 to 21 depending on the state). At that point, the trust terminates and the accounts fully belong to your child. They then have full unrestricted access to the funds. Obviously, this means that they can actually use the money for any purpose, so before this happens you might want to have a conversation with your child to explain how the accounts should be properly used. You also have to trust that your child will use the funds appropriately.

Just like starting a retirement savings account at 60 would have limited benefit, starting your child’s college trust when he’s 15 would be far less helpful. The earlier you start saving for your child’s college education, the greater the benefit. The ideal time would be when your child is born.

Imagine your child graduating from college, debt-free and entering the workplace with a head start. With the right kind of college planning, that vision is very attainable. Using a trust involves a complex set of tax rules and regulations. Before moving forward with a trust, consider working with a financial planner who is familiar with the rules and regulations for trusts in your state and can create a custom plan for your situation.