Saving For College
If you’re beginning the process of saving for college, a little knowledge can go a long way towards finding the best plan for your situation. Regardless of the specifics of a student’s choice in college and associated costs, there are many ways that you can make the process of saving for college as financially beneficial as possible. Below are a few different ways to start saving for college. Depending on your current financial situation and your savings goals, you can either stick with just one plan or combine a few different ones to get the most out of your money.
529 Plans
A 529 plan is a plan run by a state or educational organization to help individuals saving for college to set aside funds gradually for costs of higher education to be incurred in the future. Each state offers at least one of their own 529 plans, but this does not typically mean that the student will have to attend an institution specific to the state in which their plan is housed. There are two types of 529 plans: pre-paid tuition plans and college savings plans. The main distinctions of each are outlined below.
Pre-paid tuition plan: investments made in these plans are usually guaranteed by most state governments, which is why they are generally considered a more financially conservative option. Funds accumulated through this plan can be used to purchase credits towards tuition and other eligible costs, free of tax.
College savings plans: these plans allow account holders to choose between several investment options, including money market funds, stock mutual funds, and bond mutual funds. While investments made in these plans are slightly more risky, the investment options offered within college savings plans can also yield higher returns. These plans also allow those saving for college significant tax benefits, as earnings from these savings plans are not taxed, and all college costs paid for through these plans are also tax-free.
Another thing to consider in regards to 529 savings plans is that they are specifically geared towards parents saving for the college costs of their children. The parent, or owner of the account, is always in control of these funds and if they child does not go to college for some reason, the funds in the account can be transferred to another family member.
US Savings Bonds
US savings bonds are one of the simplest and easiest ways to go about saving for college. There is no need to set up complicated accounts or fill out paperwork, and these bonds can be purchased in amounts as small as $25 at a time. While these bonds are typically associated with lower returns, they are no-risk investments which allow holders to benefit from tax-free earnings over time.
Coverdell ESAs
Coverdell ESAs work much the same way as a Roth IRA, allowing individuals who are saving for college or other education expenses to make annual contributions to a federally regulated account. Below are the main characteristics of this type of account.
- Funds can then be withdrawn from this account and used for eligible education expenses, which then become tax-free
- Coverdell ESA’s have been extended to cover expenses related to elementary education and secondary school education, making them even more attractive for those looking to reap the tax benefits of saving for these types of education costs
Roth IRA
Some individuals saving for college consider using a Roth IRA for their purposes. While these are not set up specifically for higher education, they can offer the same benefits of similar education-based savings plans. Here are some key considerations when deciding whether to use a Roth IRA account as a vehicle for saving for college.
- Individuals can deposit money into a Roth IRA and earn tax-free funds throughout the life of the account
- Contributions can be taken out for any purpose, educational or otherwise, without penalty
- When saving for college expenses using a Roth IRA, the amount you will need to withdraw for education expenses should not exceed your total contributions, as dipping into account earnings before the account holder reaches the age of 59 and ½ can result in penalties
UGMA / UTMA
The Uniform Gift to Minor’s Act and Uniform Transfer to Minor’s Act are custodial accounts which have been around long before the days of 529 plans. Parents saving for college expenses in the future can use these accounts to hold money for their children until they are ready to withdraw the money to pay for the expenses of higher education. Below are some key benefits of these accounts.
- Funds are technically the property of the minor under which the account is established
- All funds are taxed at much lower rates (commonly referred to as the “kiddie tax”)
- Some funds are not subject to taxation at all
As you can see, there are many ways to go about managing the financial impact of a college education. In the long run, saving for college should be something that is well-planned and tailored to each individual to result in the maximum savings possible for each individual’s situation.
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