Saving for college can be overwhelming, but don’t let confusion over account types be the reason you delay.
When you’re researching how to pay for college, the first step is to realize it’s never too early to start an education fund. As the costs of a higher education continue to climb, starting a college savings account may be a good idea to help you achieve your goals.
For the 2018–19 school year, the average tuition and fees for public, in-state college were $9,719, according to U.S. News and World Report. The average cost of tuition and fees for a public, out-of-state college were $21,629, and the average tuition and fees for a private college were $35,676. Thosecosts don’t include room and board and other expenses, which can add thousands more to the total price of a college education.
You have choices for setting aside, investing, and and managing education funds, and it’s important to know the rules and tax implications when researching how to afford college. Let’s look at three ways to invest toward college expenses.
One way to invest toward college is through a 529 plan, an education savings plan operated by a state or educational institution. 529 funds can be used at a qualified college in any state, according to Saving for College, an information site for college saving and planning. Although 529 plans vary from state to state, they generally offer federal tax-deferred growth and withdrawals that are free from federal income taxes. There are no income or age limits, and many plans have high lifetime contribution limits.
Also, some states may offer in-state tax benefits to residents using the state 529 plan.
Here are a few things you need to know:
A 529 plan can be used for tuition costs for K-12, but the withdrawal amount and use of funds have limits. The federal law was expanded, but some states only offer tax-free withdrawals for college expenses. Withdrawals for K-12 tuition may be considered non-qualified withdrawals under some state laws, according to Dara Luber, senior manager of retirement at TD Ameritrade. Before dipping into 529 savings consider implications and alternatives that may be more advantageous, she said.
And before you buy a laptop for your fifth grader, remember that the only qualified expense for K-12 students is tuition, and it’s limited to $10,000 a year per beneficiary.
Perhaps a lesser-known savings vehicle is the Coverdell Education Savings Account. Like 529s, Coverdell plans allow earnings to grow tax free and will not be taxed at withdrawal when used to pay for qualified, education-related expenses. But unlike 529s, the Coverdell account can also be used for education expenses for children in kindergarten through high school—tuition, books, and even school uniforms.
There is a bit of a catch. The maximum annual contribution to a Coverdell account is $2,000—possibly a small percentage of annual education costs, even at the K-12 grade levels. Plus, the allowable contribution amount phases out with adjusted gross incomes of $110,000 or more for single filers and $220,000 for joint filers, according to the IRS. But Coverdell accounts can offer a variety of investment choices, and some may have lower fees than 529 plans, according to Saving for College.
How popular these plans will be remains to be seen now that 529 plans can be used for K-12 tuition. But parents will need to do some basic math when deciding how to use their 529 plans. The idea behind saving early for college is that parents have a longer time horizon to invest and potentially compound returns. Using a 529 to pay for K-12 tuition essentially draws down the balance sooner.
You can also set up custodial accounts for students under two legislative acts: the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). These allow you to transfer ownership of assets to children and have the assets held by a custodian until they become adults. Such accounts are not tax deferred, but earnings are taxed at the child’s rate, which may be lower or even exempt from federal tax, depending on the child’s total assets.
One thing to note about custodial accounts is that, because the assets belong to the student, they’ll be counted among the student’s asset base in financial aid determinations.
Planning, investing, and saving for college can be overwhelming, but knowing your choices and getting an early start can help you boost potential savings and make progress toward your goal.
An education savings plan can help you invest now toward your child’s college expenses down the road, or help fund their K-12 education as well.
Interested in learning more about college savings plans? Visit this page to discover effective planning and investing strategies for higher education.
Debbie Carlson is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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