College Savings 101: Understand Your Option & Start Early
College for my kids? Ways away, right? They may still be newborns or toddlers but the earlier you set your kids up for success the better. That’s why implementing a plan today is essential. College Board.org, a not-for-profit organization, published research showing the trends in college tuition costs dating back to 1989, revealing that over the past 40 years, college tuition rates have been constantly increasing at two to three times the rate of inflation each year.
It’s simple, saving for college over time makes infinitely more sense than borrowing and paying it off later. When you’re saving, your money earns interest; when you borrow, you’re charged interest. Every dollar saved is one less dollar you have left in student loans. Together, we can set your children up for a bright future and also work to eliminate the $1.7 trillion student debt crisis.
Understand your Options
Having a strong understanding of the options available to you will give you the confidence to choose the correct path to achieve your goals. Below are the most common options for saving and investing for your child.
If you go this route and your child does not go to college, you can use the money to meet another financial priority, such as retirement. However, the greatest drawback to saving for college with savings accounts is that they typically earn low-interest rates and may take significantly longer to reach your college savings goals.
529 College Savings Plan
529 college savings plans are one of the most popular college savings options. 529 plan earnings can grow tax-free and won’t be taxed when you choose to withdraw funds, as long as you use them for qualifying college expenses. While a 529 college savings plan is similar to a Roth IRA, there are no limits to how much you can contribute each year. You may save as much as you’d like until your account reaches a certain balance, which is usually $400,000 or more. 529 plans offer age-based investment options that can make saving for college simple yet effective. You may get a tax break or credit for contributing to a 529 college savings plan. Unfortunately, if your child doesn’t end up going to college and you don’t have another child to transfer the funds to, you’ll be on the hook for taxes and a 10% penalty fee.
A Coverdell ESA is similar to a 529 plan in that it can help you ensure your savings are used for tuition, books, room and board, and other college-related costs. When you withdraw from a Coverdell ESA, you won’t have to pay any federal taxes on it, as long as you use the money on qualified expenses. Although the Coverdell ESA may be a good option, it’s essential to understand its restrictions. It will only allow you to contribute up to $2,000 per year per child. Since the cost of higher education is increasing every year, saving $2,000 per year for 18 years or a total of $36,000 may not be enough to cover a lot of your child’s college expenses.
If you’re unsure whether your child will attend college but still want to save for their future, a custodial account can be a great option. Two of the most common custodial accounts include UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act).
There are no restrictions on how you can use the funds of a custodial account. The only caveat is that the money needs to benefit your child in some way. Custodial accounts also offer tax breaks. While the initial $1,000 is tax-free, the second $1,000 is taxed at your child’s income tax rate, and the remaining is taxed at your income tax rate. Once your child turns 18, you won’t be able to tell them what to do with the funds.
At UNest we are big fans of Custodial Accounts because of the flexibility they offer our families. No two kids are alike and we believe that having options for how funds are used makes a lot of sense for many parents who may want to help their kids buy their first home or car as well as attend school! Having this flexibility while also receiving tax benefits is a big plus.
Pick an option and Start Saving
Families who start as early as when their child is born will accrue a much more significant amount of their savings from earned on investments. For example, if you take a family who starts saving for their child’s college when their baby is born, roughly a third of the savings will come from earnings alone. For parents who wait until their child is already in high school to create a child college savings plan, less than 10% of the money in the account will come from earnings. Suppose you want to be proactive in saving for your child’s future. In that case, you can get started even sooner to reap the most tax-advantaged benefits of establishing a bank account for child education—when they’re just a baby or even before they’re born.