The cost of college continues to increase. In fact, tuition at private four-year institutions has increased 129 percent in the last 20 years. In order to meet these rising expenses, every parent needs a college education savings strategy. Depending on your income level, there are different savings options you can choose from, such as a 529 College Plan or a Coverdell Education Savings Account.
529 College Plans
A 529 education savings plan is an investment account dedicated to your child’s future qualified higher education expenses, such as tuition and room and board. The money you have saved can then be used to pay expenses at any college or university. 529 College Plans are sponsored by all 50 states and the District of Columbia.
The main advantage of a 529 plan is that earnings are not subject to Federal income taxes and generally not subject to state taxes, if they are used for qualified educational expenses. However, the contributions made to one of these accounts may not be deducted on your tax return.
With a 529 plan, you can choose from a wide range of investment portfolio options, which may include mutual funds and exchange-traded fund portfolios.
One advantage of a Roth IRA is that you can withdraw funds tax- and penalty-free to pay for qualifying educational expenses five years or more after opening the account. However, these accounts have strict contribution limits. High earners are prohibited from using a Roth IRA to fund higher education expenses.
A Roth IRA offers more flexibility than a 529 college plan. If your child chooses not to attend college, you can use the money for retirement instead. A 529 can only be used for educational purposes.
Coverdell Education Savings Account
A Coverdell Education Savings Account is a trust or a custodial account that is solely dedicated to paying for the qualified educational expenses of a designated beneficiary.
A Coverdell ESA is similar to a 529 College Plan. They offer tax-free investment growth and tax-free withdrawals if the funds are spent on qualified educational expenses. However, Coverdell Accounts have a lower threshold for maximum contributions per child. They are also only available to families below a specified income level.
If you choose to open a Coverdell ESA, contributions must be made in cash, and they are not tax-deductible. However, the account’s distributions are made tax-free.
It’s important to choose an educational savings vehicle early in your child’s life to allow your money time to grow. If you have any questions about family financial planning, contact a local accountant.