Last week we discussed building generational wealth, and we mentioned starting a 529 plan for your child’s tuition.
If your child can graduate college debt-free, that gives them a considerable advantage in entering the workforce.
But there is much more to the 529 plan than what was covered in the generational wealth article. So, this week let’s dig into the 529 plan a little deeper. While we’re at it, let’s look at a few other ways to save for your child’s college.
So, picking up from last week, there are several reasons to choose a 529 plan to save for college.
It can be used for any educational expenses. And those don’t have to be limited to college costs. Up to $10,000 per year can be used for elementary or high school tuition costs.
529 plans are state sponsored accounts, but you don’t necessarily have to pick your state’s plan. If a plan from another state has better benefits, you can usually purchase it. Of course, home states always add something for residents, such as state tax deductions. These are not ordinarily available for non-residents.
Regardless of the state plan, your saving grows tax-free, and withdrawals are also tax-free as long as they are used for educational purposes outlined in the rules.
Like any plan, though, 529’s are not perfect. They can only be purchased at the state level, and the type of investment vehicles is limited.
That lack of flexibility may mean lower returns for you.
Coverdell Education Savings Account (ESA)
At first glance, 529 plans and Coverdell ESA’s look remarkably similar. Both have the end goal of providing for education expenses, and both let you use the money for elementary and high school tuition.
The Coverdell is also easier to buy. It can be purchased in various places, including banks and online brokerage houses. It also offers a much wider range of investment vehicles than the 529. That variety can lead to larger returns.
But there are some caveats.
The Coverdell ESA was designed for households with specific income thresholds. So, only couples filing jointly with incomes below $190,000 per year are eligible. That drops to $110,000 per year for single filers.
Also, contributions are limited to $2000 per year, and no contributions can be made after the beneficiary turns 18.
Finally, if that money isn’t used by the time the beneficiary turns 30, there are penalties to pay.
If freedom and flexibility are important to you, consider opening a custodial account in your child’s name.
The money isn’t restricted to educational use. So, if your child decides not to attend college, there is no tax penalty.
It also offers wide latitude in investment vehicles, especially if you choose the Uniform Transfer to Minor Act option. You can hold cash, mutual funds, and even physical assets like real estate in a UTMA.
However, custodial accounts don’t have the same tax benefits as a 529 plan. Therefore, it would be worth talking to your tax advisor to see if the flexibility of a custodial account outweighs the tax benefits of a 529 or Coverdell ESA.
Oh, and once your child is no longer considered a minor by your state of residence, the money is theirs to do as they see fit. That’s another point well worth discussing with a tax professional.
It’s also worth discussing with your child, as well.
There you have it, three different approaches to saving for your child’s college costs.
No matter how much longer it is before your child enters college, it is worth looking into the benefits of these plans so you can give the next generation a leg up on their financial future.