If you’re like most Americans with school-age children or grandchildren, you may be wondering how you can ever save enough money to send them to college. Every year you hear that college costs are rising more than inflation and that, 18 years from now, it will cost a lot more to send your child to public or private school.
Even if you can’t save a lot, the savings you can put away now may make a big difference down the road. Selecting the right college savings plan is essential to maximizing the return on your education investment. With this in mind, we thought it would be helpful to take a look at some popular ways to save for college. We condensed the information into eight questions people frequently ask about college savings.
A: The American Funds college cost calculator can help you figure out how much a particular college will cost at the time your children or grandchildren will attend. It provides costs for a wide list of schools based on information from the College Board, as well as how much you may need to save each month to cover expenses. The calculator, combined with guidance from your financial professional, can help you work out a plan to pay for college.
Q: Why start a college savings plan early?
A: The longer you wait the more money you’ll need to save to meet your goal. By the time today’s newborns are set to enroll in college, some estimate that four years at a public university will cost more than $200,000. While getting an early start is key, it’s never too late to begin saving for the educational objectives of those you care about. Doing so can make a meaningful difference — by potentially reducing the amount you or the account beneficiary may need to borrow to pay for school.
Q: What are some tax-advantaged ways to save for college?
A: Section 529 savings plans and Coverdell Education Savings Accounts are the two most popular ways to save for college. Many investors also use custodial accounts such as those authorized under a state-sponsored Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).
Q: What is a 529 savings plan?
A: Named after Section 529 of the Internal Revenue Code, 529 savings plans provide a tax-advantaged way to save for qualified higher education expenses. These plans are generally sponsored by individual states, while plan assets are professionally managed by independent investment firms or state government agencies. Anyone can open a 529 savings account regardless of income level and contribute up to $15,000 ($30,000 for married couples) a year without gift-tax consequences.Effective for distributions taken after December 31, 2017, you can withdraw up to $10,000 each year per beneficiary for tuition incurred for enrollment or attendance at a public, private, or religious elementary or secondary school.
Q: What is a Coverdell Education Savings Account?
A: A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses. Coverdell Education Savings Accounts have been offering tax-free withdrawals for higher education since 1998. Unlike 529 savings plans, withdrawals can be used for elementary and secondary education and even for academic tutoring and education-related computer expenses.
There are income restrictions. If your income exceeds certain limits, you will not be eligible to contribute to a Coverdell account. The total annual contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established.
Q: Are UGMA and UTMA accounts still good choices?
A: For many years, UGMAs/UTMAs were the only substantial education savings vehicles available, so many investors have built up sizable amounts in these accounts.
UGMA/UTMA accounts do not have income or contribution limits. And, at least part of your earnings may be exempt from federal income tax. Some or all will be taxed at the child’s lower rate if the child is under age 18.
Contributions to UGMA/UTMA accounts are irrevocable, meaning that once the money or other property has been given, you cannot change your mind and withdraw the gift.
You can withdraw money anytime for the benefit of the child — not just for education. The child assumes control of the account upon reaching the age of majority (18 or 21 in most states).
Q: Do gift-tax rules apply to college savings plans?
A: Contributions to 529 savings plans, Coverdell Education Savings Accounts and UGMA/UTMA accounts are subject to gift-tax rules. Under these rules, you can contribute up to $15,000 a year ($30,000 for married couples) without gift-tax consequences.
Under a special election, you can invest up to $75,000 ($150,000 for married couples) to a 529 account at one time by accelerating five years’ worth of investments with no federal gift-tax consequences. If you make this election, additional contributions or other gifts to the same individual over that five-year period will exceed the annual gift-tax exclusion.
Q: What if my child does not go to college?
A: With a 529 savings plan, you can leave the money in the account in case your child decides to attend college at a later time. Or you can select a new beneficiary, including yourself or anyone who is a member of the current beneficiary’s family. If you take the money out for anything other than education, you will pay ordinary federal income tax plus a 10% penalty on the earnings.
With a Coverdell account, the beneficiary must use the assets by the time he or she reaches age 30, or a new beneficiary must be named.
For UGMA/UTMA accounts, you will owe capital gains tax on any appreciated investments inside the account when they are sold.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
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