For the most part, I don’t get stressed out a ton.
Sure I might get a bit stressed if my Fantasy team is up by 7 points going into Monday night and I need my opponent’s running back to have a lackluster game.
Other than that, I’m pretty much chill.
Do you know what does stress me out?
College tuition!
I wasn’t that stressed after we had our first son, but now I have four kiddos! <gulp>
Do you stress out about this? Please tell me I’m not the only one!
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.
Crap? Private school? My mind hadn’t even gone there yet. I’m so screwed…
Table of Contents
College Savings Plans
Even if you can’t save a lot, you can still take advantage of a college savings plan.
With this in mind, I thought it would be helpful to take a look at some popular ways to save for college.
I condensed the information into 10 questions people frequently ask me about college savings.
1. How Can I Estimate Future College Costs?
The FinAid.org cost calculator can help you figure out how much a particular college will cost at the time your children or grandchildren will attend. It’s a little more generic in nature, but it can give you a good sense of what the basic costs might be. In working with clients, I also have a software program that I use that has a list of most colleges throughout and you can get a real sense of what the estimated cost for an actual college might be.
2. Why Start a College Savings Plan Early?
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, 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.
3. What Are Some Tax-Advantaged Ways to Save for College?
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). There are pros and cons to which would be best. Most notable, is if the child does not go to school.
Typically, what I see is for parents that what to save some money for their child, but don’t want to force them to go to school, the custodian account works best. Reversing the situation, and you’ll see the other two being used, most commonly the 529 plan then the Coverdell Education Savings Account.
4. What Is a 529 Savings Plan?
Named after Section 529 of the Internal Revenue Code, 529 college 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 $17,000 ($34,000 for married couples) a year without gift-tax consequences.
5. What Are Some Features of Coverdell Education Savings Accounts?
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 though. If your modified adjusted gross income (MAGI) is less than $190,000 for filing a joint return, you will be eligible to contribute to a Coverdell account. Annual contributions are also limited to $2,000 a year.
6. Can I Invest in Both a 529 and Coverdell Account?
Yes, investments in a 529 savings account will not affect your ability to invest in a Coverdell Education Savings Account for the same beneficiary. Investing in both can be an especially good idea because the two complement one another. It’s similar to having a retirement plan at work and then also having an IRA, as well.
7. Are UGMA and UTMA Accounts Still Good Choices?
For many years, UGMAs/UTMAs were the only substantial education savings vehicles available, so many investors have built up sizeable 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).
8. Do Gift-Tax Rules Apply to College Savings Plans?
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 $17,000 a year ($34,000 for married couples) without gift-tax consequences.
Under a special election, you can invest up to $85,000 ($170,000 for married couples) in 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.
9. What if My Child Does Not Go to College?
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. Keep in mind that the 10% penalty does not apply to scholarships. This means that if your child were to receive a scholarship, you would be able to withdraw the scholarship amount from the account without getting penalized.
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.
10. What Do You Use for Your Child?
Currently, we are using an out-of-state 529 plan because I felt it offered better investment options. I will in the near future start an in-state plan as well, just as another level of diversification. While helping our kids through college is on our minds, we do not expect to fund the full tuition. If we have the money we will, but we also want our child to appreciate the gift of education.
Your Guide to College Savings: 10 Key Questions Answered
| Question | Answer |
|---|---|
| 1. Estimate College Costs | – Use finaid.org Calculator for Cost Estimates – Get a Sense of Basic College Expenses |
| 2. Start College Savings Early | – Begin Early to Reduce Total College Expenses – Late Start Can Still Help |
| 3. Tax-Advantaged Options | – Consider 529 Plans, Coverdell, or Custodial Accounts – Choose Based on Educational Goals |
| 4. 529 Savings Plan | – Tax-Advantaged Higher Education Savings – Allows up to $17,000 Annual Contributions |
| 5. Coverdell Education Savings | – Tax-Free for Education, Including Tutoring – Limited to $2,000 Annual Contributions |
| 6. Invest in Both 529 and Coverdell | – Yes, They Complement Each Other – Similar to Having Multiple Retirement Accounts |
| 7. UGMA/UTMA Accounts | – No Limits, May Have Lower Child Tax Rates – Earnings Grow Tax-Efficiently |
| 8. Gift-Tax Rules | – Contributions Subject to Gift-Tax Rules – Special 529 Election for Larger Contributions |
| 9. Child Doesn’t Attend College | – 529 Allows Saving for Future Education – 10% Penalty on Non-education Withdrawals |
| 10. Your Child’s Savings Plan | – Using Out-Of-State 529 for Better Options – Considering an In-State Plan For Diversification |
Bottom Line: 10 FAQs on College Savings
Navigating college savings requires understanding various plans and their tax implications. The rising costs of education necessitate early saving, with 529 Savings Plans and Coverdell Education Savings Accounts offering tax-advantaged benefits. While UGMA/UTMA accounts provide flexibility, they come with unique tax rules.
The flexibility of changing beneficiaries in a 529 plan is beneficial, but non-education withdrawals incur penalties. Diversifying savings, like using both in-state and out-of-state 529 plans, can optimize benefits while ensuring children value their education.
Hi there – Just a friendly observation, I think #8 needs to be updated since this article is dated August 2019. The limit is much higher now. It should be $15,000/$30,000 and $75,000/$150,000.