In my previous post, I talked about a forthcoming post on 529 plans. I will expand on that a little and cover a couple of additional options you may want to consider as well.
Take a look at the chart above by the US Bureau of Labor Statistics. No better infographic demonstrates the importance of a college education in modern day America - it is the difference between the weekly pay of $1,108 vs. $777, a whopping 42.6% difference! So parents, let's discuss a few ways how you can put some money away towards your child(ren)'s college education.
1. 529 Plans - Created by section 529 of the Internal Revenue code, the 529 is a tax-advantaged investment vehicle to encourage you to save for your child(ren)'s future college costs. Think of this as a 401(k) or an IRA, except the goal of your investment is college expenses rather than retirement income. There are 2 types of 529s - savings and prepaid.
- Savings plans - operates like a 401(k)/IRA, you invest your savings, your account gain or lose value depending on the performance of your selected investments and when the time comes, you can use the funds toward expenses for any US college and some international universities.
- Prepaid plans - allows you to purchase tuition credits at today's rates and use them in the future. In essence, you're betting that the cost of college education will continue to go up (which is a good bet) and that you will save money by purchasing credits at today's rates.
- The main benefits of a 529 plan are the following:
- Investment grow tax free and eligible distributions are tax exempt.
- While contributions are not tax deductible federally, many states will allow income-tax deduction of your contributions.
- The donor (you) are in charge of the funds. You decide on the investment and when and for what funds are withdrawn. Many plans even allow you to reclaim the funds for yourself anytime you want.
- Low maintenance - 529s are managed professionally so you can spend your time doing more productive things, like reading UpToDate.com.
- No income or age limitation - thinking about going back to get that MBA, set up a 529 for yourself!
- High ceiling for contributions - if you're a big earner, you can contribute over $300,000 per beneficiary in most plans. Although keep in mind your contributions are considered gifts so will be subjected to federal gift tax rules.
2. Now while the 529 is most recognizable name in education savings, there is another less-well known player known as Coverdell Education Savings Accounts (ESAs). It works very much like a 529 plan, with the following distinctions.
- Available if your modified adjusted gross income (MAGI) is less than $110,000 or $220,000 if filing jointly.
- You can only contribute until your child turns 18.
- Funds must be used by age 30.
- Limit of $2000/yr in contributions
- The beneficiary (your child) is in control of the funds, not you. Which means you cannot reclaim the funds as you can in the 529 plans.
- Biggest distinction - You can use an ESA for elementary and secondary education in addition to higher education!
3. Finally, if you have an IRA, whether traditional or ROTH, early distribution from the IRA can be applied towards qualified higher education expenses without the 10% early withdrawal penalty. Keep in mind you may still owe income taxes on your earnings.
These are the most common tax advantaged education savings plans you should be aware of. Of course, you can always put money away in a savings/CD/Money Market/Brokerage account but you'll be missing out on the tax benefits.