Continuing with Part II of my series on kids and money, today I’ll go over saving for college. This was a topic that I did not know a whole lot about, so I had to do quite a bit of research. However, during my research, I found an excellent website that provides just about everything you need to know regarding the two primary ways to save for education: 529 Plans and Coverdell Education Savings Accounts (ESAs). The website is savingforcollege.com. I’ll broadly cover 529 Plans and Coverdell ESAs, but I will also provide links for additional articles and topics. Also, I definitely recommend using their website for further information. Both 529 Savings Plans and Coverdell ESAs work very similar to Roth IRAs, with the big difference being that the withdrawals are only tax free if used for qualified education expenses. You’ll pay taxes on the contributions prior to putting it into the account. Both 529 Plans and Coverdell ESAs are great ways to save for college.
529 Plans
Due to their increased flexibility, 529 Plans are likely the better option when saving for college. Every state sets up their own 529 Plans, and there are two options depending on which state you are in. States can have a 529 Prepaid Tuition Plan and a 529 Savings Plan.
A 529 Prepaid Tuition Plan allows you ‘prepay’ tuition at today’s costs for certain public or private colleges. Another option for prepaid plans, depending on the state, is to ‘prepay’ for credit hours that you can apply towards courses in the future. A 529 Savings Plan is a savings and investment plan that allows contributions to grow tax-free over time, and be withdrawn tax-free if the funds are used for qualified education expenses.
While there are no annual contribution limits for 529 Savings Plans, there are maximum total account balances for each 529 Savings Plan, which vary by state. Contributions can also be made by others for 529 Plans. A recent change to 529 Plans is that up to $10,000 can be used to repay student loans, but that is a total amount for anyone with student loans, not an annual amount. Another recent change is that you can use up to $10,000 annually for K-12 tuition expenses. Three other major benefits for 529 Savings Plans are the ability to change the beneficiary, the lack of a beneficiary age limit, and the ability to transfer funds from one 529 plan to another. One negative for 529 Savings Plans is that there is a 10% penalty (on top of income taxes) for non-qualified distributions. Here are useful links with more information for 529 Savings Plan topics and questions:
“Does a 529 Plan affect financial aid?”
“How to avoid the 10% Tax Penalty on Non-Qualified Distributions?”
“Maximum 529 Plan Contribution Limits by State”
“How Many 529 Plan Investment Changes Can You Make Per Year?”
Coverdell Education Savings Accounts (ESAs)
While Coverdell ESAs are very similar to 529 Savings Plans, there are some major differences. To start, the maximum annual contribution for a beneficiary is $2,000, and there are also income limits for those contributing to a Coverdell ESA. For married couples, you can contribute the full $2,000 per year if you income is $190,000 or less ($95,000 for single tax filers). The $2,000 contribution phases out as income goes above $190,000 for married couples, and married couples cannot contribute to Coverdell ESAs if their income is above $220,000 ($110,000 for single tax filers). There is also an age limit for contributions. The beneficiary must be under 18 years of age when contributions are made, and all funds must be used by the time the beneficiary turns 30 years old. Like 529 Plans, the beneficiary of a Coverdell ESA can be changed. One major advantage of a Coverdell ESA is that they can be used for qualified education expenses for K-12, not just tuition. You can also transfer funds from a Coverdell ESA to a 529 Plan, which will allow you to avoid the under 18 age limit for contributions and the 30 year age limit for using all of the funds. Those are the main highlights of Coverdell ESAs. Below are more links to learn more about Coverdell ESAs.
Wrapping Up
With the costs of higher education continuing to rise, saving for college needs to be planned for well in advance. Coverdell ESAs, 529 Prepaid Plans, and 529 Savings Plans all provide great ways to save for college. On a slightly different note, Coverdell ESAs and 529 Savings Plans will both have fees, so do your best to be conscious of the fees and try to keep them as low as possible. For additional information on Coverdell ESAs and 529 Plans, I recommend going to savingforcollege.com to learn more.
Disclaimer: I have no association with savingforcollege.com and receive no compensation for recommending their site.
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