Choosing the Best College Savings Account
article by Matthew Ward, CFP®
With your kids back in school, now is the time to start planning for their college funding. Many individuals ask about the advantages of a 529 Plan. The truth is 529 Plans can be a great way to save for college on a tax advantaged basis. However, there may be better alternatives. Read below for the advantages and disadvantages of the different account types for college funding.
Advantages: The biggest benefit of these plans is when you withdraw these funds in the future for college expenses, the growth of the account is tax free. Contributions are not tax-deductible. A second advantage is 529 plans have no specific contribution limits, but if your contributions exceed $15,000 (for 2019) per recipient per year, you may be subject to gift tax.
Disadvantages: The first disadvantage is that if your child opts out of college, you will have money tied up that either must be passed along to another qualified relative for college, or, you risk withdrawing funds and paying taxes and penalties. Another disadvantage comes into play if you over-save with this account. You’ll be forced to pass it to a qualified relative, or risk paying taxes/penalties when withdrawing. A third disadvantage is the potential impact on financial aid availability. In brief, if a student has a 529 plan in his or her name, then financial aid providers will take those funds into account when determining the student’s eligibility and level of need.
Read NerdWallet’s article: 529 Plan Rules
Coverdell education savings account (ESA)
Advantages: If your modified adjusted gross income is under $110,000 per year for single taxpayers or $220,000 per year for married-filing-jointly taxpayers (2019), then you’re eligible to open a Coverdell ESA. The Coverdell ESAs are typically set up in the parent’s name, so they don’t have the same impact on financial aid that many 529 plans do.
Disadvantages: There are low contribution limits. You can only contribute up to $2,000 per year. Also, the account must be emptied by the time the beneficiary hits age 30, or the remaining funds will be subject to taxes and penalties.
Read The Balance’s article: A Beginner’s Guide to the Coverdell ESA
Advantages: The Roth IRA is effective for college planning. First, unlike a Traditional IRA, the Roth IRA allows you to withdraw the money you put in at any time tax and penalty free. If used for college, the Roth also allows you to avoid the 10% penalty on the growth of your investments. You will still pay income tax on the growth until you’ve held the account for over 5 years and reached the age of 59.5.
Disadvantages: Contribution limits are limited to $6000 (for 2019) for those under 50. You will not enjoy tax-free growth if you are under 59.5 years old for college expenses, as you would with the 529. Also, if you earn too much, you may not be eligible to contribute to a Roth. Please contact us or your qualified advisor to determine.
Taxable Brokerage Accounts
Advantages: The greatest benefit of these plans is your money is not tied up. There are no penalties associated with this account. You can withdraw everything including growth of the account as you wish. Another benefit is the growth of the account is taxed at the more favorable capital gains rates if held over 1 year. If you’re unsure your child will go to school, this can be an alternative to funding a college account.
Disadvantages: A disadvantage would be the potential tax free growth is lost. But if you’re unsure whether your child is going to attend college or you would like to use the account as a dual savings account for yourself as well as college, then this is a suitable alternative to all the above-mentioned accounts.
We are geared to determine the best type of college savings account for you and your children. We have expertise in setting up each of these account types and helping design an investment strategy to help you achieve your savings goals.
Or schedule an appointment with Matt at New Century Investments: