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COLLEGE SAVINGS 101

Intro To College Savings - Lesson 2
http://www.savingforcollege.com/articles/intro-to-college-savings-lesson-2

Posted: 2015-08-13

Compare your options

Lesson 1 helped you figure out how much you should be setting aside each month for college, and now it's time to discuss the type of savings vehicle to use. After all, your choice of vehicle can make a significant difference in how much you end up with in your college savings account.

Several options exist, and each has its advantages and disadvantages. Of primary importance is the opportunity for investment earnings and the associated risk of loss. But beyond that aspect other considerations exist:

  • federal and state income tax treatment, including potential tax penalties
  • gift and estate tax treatment
  • financial aid treatment
  • control and revocability
  • flexibility and ease of use

Remember, you don’t have to choose just one option—many parents successfully incorporate two or more options into their college savings strategy.

Here are the primary vehicles to consider for your college savings:

529 college savings plans—These are special investment programs operated by the states permitting you to save tax-free toward future college expenses.

529 prepaid tuition plans—These are programs offered in some states and by some private colleges allowing you to prepay future years’ tuition costs so that you do not have to be concerned about annual increases in tuition.

Coverdell Education Savings Accounts—These are tax-advantaged bank or investment accounts for a child’s future education expenses, but they have a $2,000 annual contribution cap.

Qualified U.S. Savings Bonds—Certain EE and I bonds can be purchased and later redeemed for college expenses without owing tax on the interest. Age and income limitations apply.

Parent-owned mutual funds, bank accounts, etc.—You can always save for college in traditional bank and investment accounts, understanding that the interest, dividends, and capital gains will be subject to income tax.

UTMA or UGMA accounts—Investments in your child’s name will typically be held in a custodial account under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) until your child reaches legal age and takes direct ownership. Children are usually in a lower tax bracket than their parents, although the “kiddie tax” removes that advantage if the child’s investment income rises above $2,000 in a year.

College Savings Vehicle Comparison
529 Savings Plan 529 Prepaid Plan Coverdell ESA Qualified U.S. Savings Bonds Parent-owned mutual funds/bank accounts UTMA/UGMA accounts
Federal Income Tax Non-deductible contributions; withdrawn earnings excluded from income to extent of qualified higher education expenses Non-deductible contributions; withdrawn earnings excluded from income to extent of qualified higher education expenses Non-deductible contributions; withdrawn earnings excluded from income to extend of higher education expenses, qualified K-12 expenses also included Tax-deferred for federal; tax free for state Earnings and gains taxed in year realized; special lower tax rates for certain dividends and capital gains Earnings & gains taxed to minor; first $1,000 of unearned income is tax exempt
Maximum Investment Established by the program Lump-sum of the projected cost of college at the time of contract purchase $2,000 per beneficiary per year $10,000 face value per year per owner No limit No limit
Qualified Expenses Tuition, fees, books, supplies, equipment and special needs; room & board for minimum half-time students Tuition, fees, books, supplies, equipment and special needs; room & board for minimum half-time students Tuition, fees, books, supplies, equipment, special needs; room & board for minimum half-time students; additional K-12 expenses Tuition and fees No restrictions No restrictions
Time/Age Restrictions None unless imposed by the program Restrictions on age of beneficiary at time of enrollment; usually some restriction on when benefits may be used Contributions before beneficiary reaches age 18; use of account by 30 Bond purchaser must be at least 24 years old at time of bond issue Custodianship terminates when minor reaches age established under state law None
Income Restrictions None None Ability to contribute phases out for incomes between $190,000 and $220,000 (joint filers) or $95,000 and $110,000 (single) Interest exclusion phases out for incomes between $115,750 and $145,750 (joint filers) or $77,200 and $92,200 (single) None None
Federal Financial Aid Counted as asset of parent if owner is parent or dependent student Counted as asset of parent if owner is parent or dependent student Counted as asset of parent if owner is parent or dependent student Counted as asset of bond owner Counted as student’s asset Counted as asset of the owner

Coming up:

Lesson 3: Shop for a plan

Lesson 4: Get family and friends involved

Lesson 5: How will my savings affect financial aid?

Previously sent:

Lesson 1: How much to save

Compare your options

Lesson 1 helped you figure out how much you should be setting aside each month for college, and now it's time to discuss the type of savings vehicle to use. After all, your choice of vehicle can make a significant difference in how much you end up with in your college savings account.

Several options exist, and each has its advantages and disadvantages. Of primary importance is the opportunity for investment earnings and the associated risk of loss. But beyond that aspect other considerations exist:

  • federal and state income tax treatment, including potential tax penalties
  • gift and estate tax treatment
  • financial aid treatment
  • control and revocability
  • flexibility and ease of use

Remember, you don’t have to choose just one option—many parents successfully incorporate two or more options into their college savings strategy.

Here are the primary vehicles to consider for your college savings:

529 college savings plans—These are special investment programs operated by the states permitting you to save tax-free toward future college expenses.

529 prepaid tuition plans—These are programs offered in some states and by some private colleges allowing you to prepay future years’ tuition costs so that you do not have to be concerned about annual increases in tuition.

Coverdell Education Savings Accounts—These are tax-advantaged bank or investment accounts for a child’s future education expenses, but they have a $2,000 annual contribution cap.

Qualified U.S. Savings Bonds—Certain EE and I bonds can be purchased and later redeemed for college expenses without owing tax on the interest. Age and income limitations apply.

Parent-owned mutual funds, bank accounts, etc.—You can always save for college in traditional bank and investment accounts, understanding that the interest, dividends, and capital gains will be subject to income tax.

UTMA or UGMA accounts—Investments in your child’s name will typically be held in a custodial account under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) until your child reaches legal age and takes direct ownership. Children are usually in a lower tax bracket than their parents, although the “kiddie tax” removes that advantage if the child’s investment income rises above $2,000 in a year.

College Savings Vehicle Comparison
529 Savings Plan 529 Prepaid Plan Coverdell ESA Qualified U.S. Savings Bonds Parent-owned mutual funds/bank accounts UTMA/UGMA accounts
Federal Income Tax Non-deductible contributions; withdrawn earnings excluded from income to extent of qualified higher education expenses Non-deductible contributions; withdrawn earnings excluded from income to extent of qualified higher education expenses Non-deductible contributions; withdrawn earnings excluded from income to extend of higher education expenses, qualified K-12 expenses also included Tax-deferred for federal; tax free for state Earnings and gains taxed in year realized; special lower tax rates for certain dividends and capital gains Earnings & gains taxed to minor; first $1,000 of unearned income is tax exempt
Maximum Investment Established by the program Lump-sum of the projected cost of college at the time of contract purchase $2,000 per beneficiary per year $10,000 face value per year per owner No limit No limit
Qualified Expenses Tuition, fees, books, supplies, equipment and special needs; room & board for minimum half-time students Tuition, fees, books, supplies, equipment and special needs; room & board for minimum half-time students Tuition, fees, books, supplies, equipment, special needs; room & board for minimum half-time students; additional K-12 expenses Tuition and fees No restrictions No restrictions
Time/Age Restrictions None unless imposed by the program Restrictions on age of beneficiary at time of enrollment; usually some restriction on when benefits may be used Contributions before beneficiary reaches age 18; use of account by 30 Bond purchaser must be at least 24 years old at time of bond issue Custodianship terminates when minor reaches age established under state law None
Income Restrictions None None Ability to contribute phases out for incomes between $190,000 and $220,000 (joint filers) or $95,000 and $110,000 (single) Interest exclusion phases out for incomes between $115,750 and $145,750 (joint filers) or $77,200 and $92,200 (single) None None
Federal Financial Aid Counted as asset of parent if owner is parent or dependent student Counted as asset of parent if owner is parent or dependent student Counted as asset of parent if owner is parent or dependent student Counted as asset of bond owner Counted as student’s asset Counted as asset of the owner

Coming up:

Lesson 3: Shop for a plan

Lesson 4: Get family and friends involved

Lesson 5: How will my savings affect financial aid?

Previously sent:

Lesson 1: How much to save

 
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