Saving for college with a 529 College Savings Plan
Saving for College: Your Options
There are a few different ways to save for college, each with their own advantages and disadvantages.
Traditional Savings Accounts
Traditional savings accounts at banks are designed for conservative individual saving. While there isn’t much return or tax benefits to keeping your funds in a savings account, it’s a viable option for an individual hoping to build a starter savings account.
UTMA Account & Coverdell ESA Funds
Uniform Transfers to Minors Act (UTMA) account funds can be used for anything related to care for a child; therefore, can be applied to a child’s college education. The challenge of using this account is that the funds belong to the beneficiary once they reach the age of 21 and can be used freely. Thus, these funds can be contributed to post-secondary education expenses but are not specifically designed for this purpose.
A Coverdell Education Savings Account (Coverdell ESA) is a reliable option for investing in a child’s college education. However, these accounts are not often preferable to a 529 College Savings Plan, as a Coverdell ESA has lower contribution limits.
529 College Savings Plans
A 529 College Savings Plan tends to be the most appropriate avenue to save for college, as the plan comes with different tax benefits and a parent/custodian maintains control of the assets regardless of the beneficiary’s age. The savings collected in a 529 College Savings Plan can also be invested in stock mutual funds, bond mutual funds, or asset allocation mutual funds, providing various options for your investments.
Each state sponsors its own 529 Plan; however, you can use any state’s plan regardless of where you reside. Most states provide a state tax deduction or credit on contributions to the plan, and you won’t be taxed on the gain if it is used for qualifying education expenses.
Eligible Expenses & Institutions
Qualified expenses include:
- Tuition and fees
- Books and supplies
- Expenses for special needs services
- Purchase of a computer or software necessary for completing assignments
- Room and board, if enrolled at least half-time
- If the beneficiary obtains a scholarship or receives free tuition under the GI Bill, you may withdraw amounts equal to the value of the scholarship and avoid the 10 percent penalty. You still nonetheless must pay tax on the earnings
Qualified institutions included in tax-free withdrawal:
- Four-year colleges (both for undergraduate and graduate school)
- Community colleges
- Some technical schools
- Some states allow for qualified withdrawals for K-12 private school tuition (up to $10,000 can be withdrawn each year per beneficiary)
There are several items that do not qualify as education expenses, including personal living expenses, transportation to and from school, repayment of student loans, student insurance premiums, and Greek life membership dues. In the event that you withdraw contributions for non-qualified expenses, you will have to pay the income tax you avoided, as well as a 10 percent penalty on investment gain over original contributions.
A 529 College Savings Plan provides tax benefits and other advantages for individuals building a savings fund for higher education costs. To learn more about your options and how to start a 529 Plan, please contact a Sikich Financial professional.