College savings options

By Published On: February 3rd, 2010

When you’re staring down into those twinkling little eyes it’s […]

When you’re staring down into those twinkling little eyes it’s hard to imagine your baby graduating from diapers—much less high school. However sad it may be to think of your baby careening into adulthood, it’s important to take a little time to prepare for his or her future.
piggybankWhether you plan to fund four years of college and beyond or you hope to pay for their education through student loans and work programs, setting a little cash aside early in your child’s life can make a substantial dent in those future bills from the bursar’s office. The exact cost of your child’s schooling probably can’t be determined on your way home from the hospital. Private versus public, in state or out—many variables contribute to the overall cost of education. The good news is you don’t need those answers now to start saving for your child’s future.
529 plans are very popular—you can start with an investment as low as $25 and depending on the state, put up to $300,000 towards your child’s future education. Since the money is legally seen as a gift, you can donate up to $12,000 per year tax-free (double that if you and your spouse both contribute). With a college savings plan the money can be withdrawn, tax-free, to pay for tuition, books, room and board and supplies at any accredited college, public or private, in the United States. If you already know your babe’s alma mater, then a prepaid tuition plan may be for you.
A prepaid tuition plan follows the same rules, but allows you to pay for your child’s future education at a specific public, in-state college at today’s rates. You can choose to pay for part or all of the tuition, but keep in mind your kiddo may have a different idea about where he’d like to go. If this turns out to be the case, the money you put into the prepaid tuition plan isn’t lost, but you or your child will be responsible for making up the difference down the road. Overall, 529 plans are incredibly flexible, allowing you to withdraw money whenever you’d like and open multiple accounts.
Although they’re popular for their no-hassle appearance and state income tax deductions, watch out for enrollment and management fees. Some brokers can charge so much that your interest becomes negligible. And remember, your return can fluctuate depending on the stock market—if this worries you, put your money into a low-risk fund. Also, you should think twice before removing the money from the account for anything other than schooling purposes—you’ll be required to pay the income tax and you’ll be nailed with a steep penalty fee.
Individual Retirement Accounts (IRAs)
IRAs allow you to gain interest on money you’re putting towards college expenses; however, you won’t see the same tax benefits that you could gain with other plans. A Roth IRA is not tax deductible, but you can remove your contributions at any time without penalty—only dipping into the account’s earnings before you are 59 1⁄2 will result in having to pay income tax. This means if you’re in a bind, you can always withdraw your initial investment from your Roth with no problems.
Also, IRA’s are traditionally retirement funds, so if your child chooses not to go to college, or perhaps receives a fully-paid scholarship, you can reap the full benefits of the IRA after you reach the 59 1⁄2 mark and use the tax-free money for other purposes. It’s also important to note that there’s a limit to the amount of money you can invest per year, so if you use an IRA towards your kiddo’s higher education, you’re essentially chipping away at your retirement fund, cutting off years of interest-fueled earnings.
Coverdell Education Savings Accounts (CESA)
CESAs are similar to the Roth IRA, but instead of funding your retirement, the money is specifically for education. Unlike other education savings plans, a Coverdell account allows you to pay for any of your child’s school related experiences (including tutoring, computers and supplies), from kindergarten all the way through college. You can contribute up to $2000 a year of your after-tax income, and barring any misuse of the money, it can be withdrawn tax-free.
Unlike a 529 plan, you have the freedom to choose from many different investment avenues, meaning you can be as conservative or risky with your money as you’d like. However, there are strict rules to qualify for a Coverdell account. Your child must be under 18 to have contributions made in her name and the money must be used by the time she’s 30. If you’re married and your household income exceeds $220,000 (or single and over $110,000), then you cannot contribute to a Coverdell account.
Custodial accounts
Custodial accounts are set up and dictated by you, the parent, for your child to receive when they reach adulthood—generally 18 or 21. You set the parameters of the account—how much is contributed, how the money is invested and when money can be taken out for purchases that benefit your child. These accounts are nice because there is no limit to the amount you can contribute, and household income holds no bearings on when or how much you can deposit.
However, since the account legally belongs to your child, the money is at their disposal once he comes of age—meaning not only can it be spent on anything, but the grand total of their new found assets can count against those seeking financial aid for education purposes. And with the exception of a few hundred dollars of your initial investment, you can also expect the money to be taxed upon withdrawal.