College Savings Options

| April 11, 2012 | 0 Comments

The cost of attending college has been rising faster than the rate of inflation for years and is expected to continue on this pace for years to come.  Parents who are interested in planning for their children's higher education need to consider which option(s) best meets their needs.  Some options allow for tax-deferred savings while others offer more flexibility in how the funds are invested.  The choices range from 529 plans that require the student to attend a school in the state that sponsored the plan to taxable accounts that allow complete flexibility.

The three main choices along with abbreviated explanations for college savings are:

  1. 529 College Savings Plan – Each state has its own plan(s).  Georgia's "Path2College" 529 plan does not limit the student to attending a school in Georgia.  TIAA-CREF manages the funds for fairly low fees.  All Georgia taxpayers may now contribute and deduct up to $2,000 each year (for state tax purposes) on behalf of any beneficiary regardless of their annual income.  Typically withdrawals are tax-free when used for qualified higher education expenses,  but may be subject to income tax and an additional 10% federal tax penalty on earnings.  The good news is that there is no limit to how much you can contribute per year, although total contributions are limited to $200,000 per beneficiary and gift taxes apply for donations over $13,000 ($26,000 per couple) per year.  The downside to 529 plans is that the choices are limited.  The choices are not bad investments.  They just are not as flexible as a taxable account or a Coverdell ESA.  Georgia's 529 plan is not available through Financial Advisors, only directly through TIAA-CREF via the link above.  Your Advisor should be able to help you work out how much you need to allocate to your child's 529 versus other investment vehicles.   As an additional note, tax laws are under review for 529 plans and the ability to withdraw funds tax free might change in the near future.
  1. Coverdell ESA – Total contributions into a Coverdell Education Savings Account (ESA) are limited to $2,000 annually per child.  This includes all contributions from parents, grandparents or any other source.  ESA contributions are not tax deductible, but funds grow tax free (as in a Roth IRA) and withdrawals are tax deductible when used for qualified education expenses.  Unlike a 529 plan, withdrawals from an ESA can also be used for expenses for private or religious schools that provide elementary or secondary education.  Contributions eligibility is phased out starting at adjusted gross incomes of $190,000 for joint filers ($95,000 for single filers) in 2014.  For more information, visit IRS.Gov.  TD Ameritrade and Charles Schwab (among others) offer Coverdell Plans with easy sign-up processes and plenty of investment choices with low fees.
  1. Taxable Savings/Investing Account – The downside to investing 100% of expected college expenses in tax deferred accounts is the possibility that not all of the funds will be used for education and the remaining funds will have to be withdrawn with a penalty.  Some investors opt to split their investments between tax deferred accounts such as one of the two choices above and a regular investment account.  Funds in regular brokerage or savings account do not have any tax breaks, but have no restrictions on withdrawal or investment choices and do not have restrictions to be used for education.  Parents who are not sure of their child's college plans and expected expenses (i.e. state school vs Ivy League) should consider allocating more of their investments towards a taxable plan.  Talk to your AF Capital Management representative for more information.

The sooner one starts saving for college, the better growth opportunity the funds have - no matter which investment choice(s) a parent chooses.  If investing in stocks and bond funds seems too risky, savers can also buy EE Savings Bonds directly from the government.  Savings bonds are low risk, but provide a negative return when inflation is factored in due to the current (2012) interest rates at extremely low levels.

In addition to making contributions to a college savings account, parents, grandparents, aunts and uncles should also check out Upromise as a free way to earn additional college money as cash back rewards from purchases at participating restaurants and stores.  Before making college the sole focus for investments, keep in mind that loans are available for college expenses, but not for retirement.  Do not neglect retirement savings while trying to reach college savings goals.

Here is a brief comparison of these two options that offer tax-deferred growth:

529 College
Savings Plan

Coverdell Education
Savings Account

Ownership/
Control
Contributor Contributor
Investment
Choices
Typically, plans provide several investment options, but most states only have 1-2 broker choices. No restrictions
Age Limits None Except for special needs children, no contributions can be made after a child reaches age 18, and withdrawals must be made before beneficiary reaches age 30.
Expenses Covered
Besides Tuition
and Fees
Qualified education expenses for post-secondary education Qualified elementary and secondary education expenses or qualified higher education expenses
Contribution
Limit
Varies from plan to plan. Majority of plans permit total contributions in excess of $200,000 per beneficiary. Contributor: $2,000 per beneficiary per year                       Beneficiary: $2,000, does not matter how many ESAs are set up.
Federal Tax
Advantages
Earnings grow tax-deferred and are tax-free if used for qualified education expenses. Earnings grow tax-deferred and are tax-free if used for qualified education expenses.
State Tax
Advantages
Varies from state to state, but some states provide tax deduction for contributions, tax-free earnings growth and tax-free withdrawals for qualified education expenses. Earnings grow tax-deferred
Income Phase-Out None Single filers:
$95,000 – $110,000               Joint filers:
$190,000 – $220,000
Penalties for
Non-Qualified
Withdrawals
Earnings are taxed as ordinary income and may be subject to 10% penalty. Withdrawals that exceed the beneficiary's education expenses for the year may be taxable and subject to a 10% penalty.
Filed Under: Planning


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