The Ins and Outs of 529s and other College Planning tools
As we enter into mid-August, now is the time to be thinking about starting (or adding to) a college fund for your child, or grandchild. There are several strategies that make using brokerage accounts, 529s, and sometimes Roth IRAs, a tax-intelligent way to build savings for college.
Please note: This writing does not include all of the rules around distributions and other considerations or the ideas for qualifying for Financial Aid or Investment Considerations. This discusses primarily the differences in investment vehicles available for building tax-intelligent college savings. Make sure to give us a call with any individual questions so we can determine according to your situation more closely. Not discussed are grandparent 529’s among other plans.
A 529 Plan:
A 529 plan is kind of like a Roth IRA, but for qualified education expenses. These do not permit a tax deduction today, but you do achieve tax-free growth on earnings if used for college and some other qualified expenses. See an article from the College Investor here for a complete review. For those looking to dive into the characteristics, see this article from Kiplinger article on 529s.
A Roth IRA:
The benefit of using a Roth IRA in conjunction with a 529 is the flexibility, dual benefit, and peace of mind. For instance, if your child does not end up going to school, you’ll have to hand the 529 over to a qualified relative or pay a 10% penalty. The Roth IRA avoids this because, simply, if the child doesn’t end up in school, then either you or your child will have retirement savings. Now, this strategy is one to be prudent when exercising. Your child or teenager will have to qualify with “earned income”, if they wish to set up a Roth. One strategy would be setting up a Roth IRA for minor account and funding this in conjunction with a 529. The other would be putting the Roth IRA in the parent’s name. There are rules around funding Roths so make sure to contact us. If you have the financial means to fund all 3, then that’s what you would want to do. But remember, for the child to have a Roth IRA they must have income. If you’re a business owner, you might be able to compensate for administration or marketing services. Again, please make sure to contact us so we can assess your personal situation.
A Brokerage Account:
This offers flexibility and no limitations. You can add long-term money that will grow for your future college goal. This account can also function as a liquid investment account that is available to you with no penalty. So that is nice and works well with the 2 above. The account is not tax-deferred, however, with the flexibility of contributions and higher rate of return than a bank or CD, this is another optimal account type to add savings for college.
A Coverdell ESA:
In order to qualify for a CESA, your income in 2021 needs to be under $190,000 married filing joint (or under $95,000 if filing single). If you make over $220,000 married ($110,000 single) you cannot contribute anything. There are also other limitations. So, these are not the most popular choices for funding college expenses. They work like a 529 for tax purposes, meaning you will not receive a tax deduction for adding money into a CESA, the earnings will be tax-free (for qualified education). The max contribution limit is low, $2,000 per year, and that is per child (which is unlike the 529 that allows 1 individual to gift up to $75,000 each for a 5-year period, so in theory a child could receive multiple deposits). However, this account still has advantages. Depending on how the account is structured, CESAs may be treated as a child’s asset for FAFSA, unlike the 529 plan, which falls under the parent’s assets usually.
These are options, to name a few, that would be reasonable to consider for funding your child’s college goal. If you have questions or would like to review your current college plan, please feel free to contact me below.
Matt Ward, CFP®
New Century Investments