Hassle-Free Saving For College

Costs associated with colleges are increasing with every passing year. This makes saving for higher education a challenge. It is hard for parents to make last-minute arrangements for tuition fees, books, accommodation, etc. Many people also do not want their children to suffer under the burden of hefty education loans. Therefore, it becomes imperative to follow a carefully formulated savings proposal from the very start. Early planning can make it easier to save funds for college. Here are some savings plans that parents can establish to cover the costs of higher education expenses. 

Coverdell education savings account (ESA)

Coverdell ESA is a perfect saving instrument for parents belonging to low-income groups. Investors can invest in the account after the payment of tax and the returns from the account are tax-exempt. Each year, the investor is allowed to contribute a maximum of $2,000 for each child. An ESA usually earns a higher rate of return than a savings account. The investor can opt for almost any investment plan under an ESA and the rate of earnings entirely depend upon the plan that is selected. This instrument is most useful when established upon the birth of the child. The withdrawals made to fund educational costs are also tax-free.

Custodial Uniform Transfer to Minors Act/Uniform Gift to Minors Act (UTMA/UGMA)

Any adult is permitted to set up a custodial account under UTMA or UGMA, with a minor as the beneficiary. One of the important aspects of this platform is that there are no limitations on the benefactors of this account. Anyone from within or outside the family can contribute to a custodial account. In addition to this, there are no limitations on the amount of contributions. The beneficiary age limit for the account varies for every state and lies between 18 and 21 years. Since the minor beneficiary is considered the owner of the account, the Internal Revenue Service levies a minor’s tax rate on the returns.  A specific amount of unearned income is taxed at a lower rate for a child below the age of 19. For a full-time student this age threshold is below 24 years. While an unearned income of $1,050 is exempted from tax, the subsequent income of $1,050 is taxed at the rate of 10%. Any income beyond this is taxed as per the amount chargeable to parents. Once the minor reaches the legal age, the account gets transferred to him/her. A significant advantage of choosing this account is that funds can then be utilized by the beneficiary for other purposes as well and are not necessarily limited to education costs.

529 savings account

A 529 savings account can be established by an adult to fund qualified higher education expenses. Each state has different investment plans, but the investor is not restricted to opt for a plan from his/her residing state. A plan from one state can be used to fund education in another state too. No tax has to be paid on earnings and distributions, provided the funds are only used for the qualified education costs. Some states also offer other tax benefits like income tax return deductions.  The owner of the account exercises complete control over the utilization of funds and no authority is given to the beneficiary student. There are no income thresholds, implying that the investor can belong to any income group. The contribution limits are also considerably high. Additionally, a 529 account entails an option to transfer the funds from one beneficiary to another. Therefore, in case there is an excess amount in one child’s account, it can be used to fund the education of the other child. Furthermore, the investment in a 529 account has a limited adverse effect on the student’s financial aid eligibility.  

Roth individual retirement account (IRA)

A Roth IRA can be established not only for retirement but to fund children’s higher studies too. The returns from a Roth IRA are not taxable. In addition to this, the withdrawals are exempted from any tax if the funds are utilized for qualified educational expenses. However, one can only withdraw the amount that has been invested without any tax burden. If an investor under the age of 59.5 years withdraws money over and above the principal amount (irrespective of the usage of funds), he/she will be liable to pay tax. This happens because the excess withdrawal amount is treated as earnings. There is also an option to convert the money that is left after covering the education costs into retirement funds. Such conversions do not impose any tax or penalty. However, a Roth IRA can only be established by a person who has some form of earnings. There are also limitations associated with the amount that can be contributed to these accounts. The contribution limits depend upon whether the returns are being filed jointly or as individuals or a widow/widower. Roth IRAs are also imposed with income restrictions, implying that people in high-income categories cannot invest in them. Ideally, this account is a practical platform for saving for low-income groups.

Education savings bond program

When a taxpayer redeems a savings bond, the interest earned is taxable. However, an eligible taxpayer has an opportunity to avoid complete or partial payment of tax on the interest by enrolling in an education savings bond program. This is possible when the principal and interest amounts are utilized to fund qualified higher education expenditure. The taxpayers can use the funds for their educational needs or those of their spouses or children. The eligibility criteria requires the bond owner to be a minimum of 24 years at the time of purchase. The funds must also be utilized to pay costs associated with tuition, which does not include books, accommodation, sports programs, etc. These payments must be made during the same year as the redemption of the bonds to avoid tax payments. This program allows payment of fees related to laboratories and degree-required courses.  

To sum it up

Parents have many options to choose from when deciding the right investment instrument to save for the future education costs of their children. However, each method may not be suitable for everyone. A sound and informative decision should be made based on various factors like income and distribution limitations, number of children, the tentative amount that needs to be saved, expected earnings, tax liabilities, etc. These fundamentals require a comprehensive analysis.

If you are uncertain about how and where to save and finding it difficult to make a decision, you can reach out to experienced financial advisors.