Guest blog post by Hal Bundrick
That little bundle of joy cooing gently in her crib is going to cost you nearly a quarter of a million dollars from birth to age 17, according to the Department of Agriculture. And of course, worth every penny. But notice that this estimate doesn’t even include the cost of a college education. You gasped just a bit, didn’t you?
Choosing the right savings vehicle for your child’s education will depend on your tax situation, ability to regularly contribute and whether you want to strictly allocate the funds for education, or let your child-turned-adult decide how to spend the assets.
This is where college savings accounts began. Uniform Transfer to Minors Act (UTMA) or gift accounts (UGMA) were traditional ways to stash cash for college, prior to 1986 tax law changes. These custodial accounts remain available, and some people still use them, though there is no tax advantage.
When establishing and funding one of these trust accounts, remember that it is an irrevocable gift to the child. The investments must be managed for the future benefit of the minor. Once the child becomes a legal adult, at age 18 or 21 depending on the state, the trust is terminated and they gain full control of the investments. Your little baby – now grown woman — can use the assets for whatever purpose she desires: whether it’s for college or a sporty new car.
Education Savings Accounts
Coverdell Education Savings Accounts can be used not only for qualified college expenses but elementary and secondary education expenses, as well. The maximum annual contribution is only $2,000, but if you start early and contribute every year, it can really add up.
Setting aside $2,000 every year for 18 years earning a 6% return can amount to over $70,000. And investment growth, as well as withdrawals for qualified expenses, is tax-free.
Prepaid tuition plans
Many states offer prepaid tuition plans that allow residents to purchase credits for future tuition, and sometimes even room and board, at eligible colleges and universities. The sponsoring state usually absorbs most, if not all, of future tuition price hikes – but remember, when states face tight budgets, promises can change.
529 college savings plans are among the best values for serious education savers. Each state sponsors at least one version of a 529 plan that allows contributions and investments made on behalf of a beneficiary. And 529 plans have significant tax advantages, allowing for federal tax-free growth and withdrawals for qualified education expenses. States that levy income taxes usually allow a similar tax advantage – and some states offer additional benefits including tax credits, deductions and subsidies to residents who contribute to 529 plans.
These college savings plans generally allow for hefty annual contributions, though the maximum amounts vary from state to state. Donors can often choose from a wide variety of investments, including “target-date funds” that move from aggressive investments to more conservative holdings as the beneficiary nears college enrollment.
And a 529 plan offers unique flexibility: if the original beneficiary doesn’t use the assets, you can assign the plan benefits to another recipient facing educational expenses – including yourself!
NerdWallet Inside Tip: You can usually save quite a bit in fees by enrolling directly in your home state’s sponsored plan, rather than signing up through a brokerage firm.
Avoid tapping retirement assets
Tapping an IRA for qualified educational expenses is allowed without penalty by the IRS but is an option of last resort that should be carefully considered. Withdrawals can trigger income taxes, though there are some exceptions but most importantly, retirement accounts should be protected for the important reason they were designed: life after work.
Your children can find alternate sources for funding an education, such as grants, loans and part-time jobs. There are even loan forgiveness programs for graduates who enter public service occupations. Unfortunately, funding a retirement has few such options.
All content contained in this blog post is for informational purposes only and should not be relied upon to make any financial, accounting, tax, legal or other related decisions. Each person must consider his or her objectives, risk tolerance and level of comfort when making financial decisions and should consult a competent professional advisor prior to making any such decisions. Any opinions expressed through the content in this blog post are opinions of the particular author only.