It is never too early to start thinking of saving for college. Yesterday, we talked about things to consider when developing a college savings plan. Today we’ll review various college savings options in more detail.
College Savings Plan Considerations
When choosing a savings plan, you should be aware of the following:
- Maximum contribution per year: Some savings vehicles limit the amount of money you can invest per year.
- Ownership restrictions: You may be able to put the account in your name or your child’s name.
- Financial aid impact: Some accounts are considered as assets for financial aid purposes, while others are not.
- Tax implications: Accounts may give a tax break at either contribution or distribution.
529 College Savings Plans
- Special characteristics: 529 plans are administered by states and help you qualify for both state and federal tax breaks. Account specifications differ from state to state. Many states (like Ohio) allow anyone to invest in their plan, but only offer state tax breaks to their own residents. 529s can be established for people of all ages and can pay for any post-secondary education expenses, including graduate or continuing education for a student of any age.
- Maximum contribution per year: None. Many states will cap total contributions somewhere around $300,000 per beneficiary. However, you should be aware that contributing more than $12,000 per year could trigger gift tax implications.
- Ownership restrictions: Account owners are those who open and fund the accounts, as well as choose the investments. Beneficiaries are those whose college expenses are paid by the account distributions. One person can be the owner on multiple accounts, each with one beneficiary. One beneficiary can benefit from multiple accounts. Each account can only have one beneficiary at a time, though the beneficiary can be changed. This is helpful if you open an account before your child is born, or want to transfer remaining funds if a child does not go to college or finishes college without spending the entire balance.
- Financial aid impact: 529 plans with the financial aid applicant as a beneficiary are considered in the financial aid process. All funds are considered available to help fund the expected family contribution.
- Tax implications: 529 contributions are often deductible for state income tax purposes when using home state plans. Distributions for qualified education expenses are tax-free. Distributions for other purposes will trigger a federal capital gains tax on any earnings equal to the owner’s tax rate plus a 10% penalty.
- Special characteristics: Coverdells are established for children under 18 at the time of funding. All funds must be spent or transferred to another beneficiary before the initial beneficiary reaches 30, or a penalty is assessed.
- Maximum contribution per year: $2,000 per beneficiary, even in multiple accounts with different owners.
- Ownership restrictions: In 2009, account owner income must not exceed $220,000 for owners who file joint taxes and $110,000 for single filers.
- Financial aid impact: All funds are considered available to help fund the expected family contribution.
- Tax implications: No deduction or exclusion for contributions. Distributions for qualified education expenses are tax-free. Distributions for other purposes will trigger a federal capital gains tax on any earnings equal to the owner’s tax rate plus a 10% penalty.
- Special characteristics: As you probably know, Roth IRAs are actually retirement accounts that allow for distributions before retirement age in certain situations. Roth IRAs can be attractive for education funding because there are no set beneficiaries and they do not impact financial aid awards. However, education distributions can be subject to taxes, unlike distributions for other purposes. Roth IRAs should not be used for education funding without careful consideration of the impact on your general financial health.
- Maximum contribution per year: $5,000 per year in 2009.
- Ownership restrictions: Eligibility to establish a Roth IRA phases out above a certain income ($166,000 for taxpayers filing jointly in 2009).
- Financial aid impact: Retirement accounts are not considered assets for financial aid purposes, meaning they will not reduce the amount of aid your student is eligible for.
- Tax implications: When used for qualified expenses, Roth IRA distributions will be subject to income tax but NOT the 10% penalty for non-qualified distributions. If the account owner is 59 ½ at the time of distribution, no tax or penalty applies.
In addition to the vehicles above, you could choose to use a simple high-interest savings account or a taxable investment account. Keep in mind that these options may limit growth and/or tax benefits.
Saving for college in advance is always a good idea, regardless of what vehicle you choose to use. With a little planning, you can minimize taxes, maximize financial aid, and help your child pay for college with as little damage to your wallet as possible.
While 529 accounts are the most common and make the most sense for the average investor, every option mentioned here can make sense in a particular situation. Consult your own financial advisor or a college savings expert to develop a college savings plan tailored to your financial situation.