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.
- 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
- 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
- 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.
- 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
- Money can be used for anything beneficial to the minor by the custodian
- No contribution limits
- 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.
*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.