We’re midway through July and despite the pandemic college tuition payments are creeping up quickly. College is becoming an insurmountable and somewhat terrifying expense for many these days, but there are a few savings vehicles that can help us battle its high costs with the power of tax deferred growth. Here’s the quick rundown on the three we see most often.
The 529
Pros
- High contribution limit ($500,000 per beneficiary)
- Money grows federal tax deferred
- Money and earnings come out tax free if used for qualified higher education expenses
- Treated as parental assets for FAFSA no matter what type of account you have
- Beneficiary can be changed (as long as it’s not a Custodial 529)
- Contributions may be deductible from state taxes. Depending on the plan you invest in and state you live in
Limitations
- Anyone contributing to a 529 other than their own needs to worry about the gift tax exclusion limit ($14,000/yr. for and individual or $28,000/yr. for a couple). Gifts can be front loaded, however, and you can give 5 years’ worth of gifts up front to give the money more time to grow.
- Money can only be used for qualified educational expenses. If they aren’t, withdrawals are treated as normal income with a 10% penalty on the earnings.
The Coverdell ESA
Pros
- Earnings grow tax free
- Qualified withdrawals are tax free
- Money can be used for elementary, secondary, and higher education
- Beneficiary can be changed
- Counted as a parental asset for aid purposes if owned by parent.
Limitations
- Contribution limit is $2000/yr per beneficiary
- Can’t contribute to one if income is over $220,000 for married couple or $110 for individual
- Beneficiary can take ownership at age of majority
- Non-qualified withdrawals are subject to normal income tax and earnings get a 10% penalty.
UTMA a.k.a. Custodial account
Pros
- Money can be used for anything beneficial to the minor by the custodian
- No contribution limits
Limitations
- Contributions treated as gifts so watch out for the exclusion again.
- Earnings don’t grow tax deferred and are reportable income for the minor. Can cause taxes for parents.
- Minor can take ownership of funds at age of majority.
- Treated as beneficiary’s money for aid purposes.
Happy saving.
*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.