"Saving For College"
"Saving For College"
Estimate Your College Savings Needs
Don't be daunted by the amount you have to save to pay for a college education. Small amounts of money, if invested early, can become sizable investments through smart planning and compounding. However an important part of saving is estimating future college cost. When estimating future college costs, remember to factor tuition, room, board and books into your calculation. If you know where you want to go to college, but don't know the current costs, you can use the National Center for Education Statistics' school locator to research the costs. If you are unsure where you want to go to college, you can get national public and private school averages from The College Board.
Different Ways To Save
According to our annual College Savings Survey, 68% of respondents have already started saving for college using a variety of different accounts. And 44% of those who aren’t saving say they haven’t started because they don’t have time to research their options. For you, I have listed six common ways you can start a college fund, and the biggest pros and cons of each:
1. Mutual Funds
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds.
Pros:
- The funds you save in a mutual fund can be spent on anything – cars, airline tickets, computers, etc.
- There’s no limit as to how much you can invest here are more than 10,000 mutual funds available, with a wide variety of investment options.
Cons:
- Earnings in a mutual fund are subject to annual income taxes.
-Any capital gains are taxed when shares are sold.
-Mutual funds assets owned by a parent will reduce financial aid eligibility by up to 5.64% of the account value, and by 20% if owned by the student.
2. Custodial accounts under UGMA/UTMA
UGMA/UTMA Accounts. UGMA/UTMA accounts allow a child to own assets once they reach adulthood, and can help pay for education expenses. The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) are types of custodial accounts that are set up by an adult on behalf of a minor.
Pros:
- Money saved in a custodial account can be spent on anything – cars, airline tickets, computers, etc, as long as the funds are used for the benefit of the minor.
- There is no limit as to how much you can invest.
- The value of the account is removed from donor’s gross estate.
Cons:
- Earnings and gains are taxed to the minor and subject to the “kiddie tax” - unearned income over $2,100 for certain children through age 23 is taxed at the marginal rate applicable to trusts and estates (in 2018).
- The student will gain rights to the account once he or she reached legal age, and can use they money at their own discretion.
- Custodial accounts are counted as a student asset on the FAFSA, which means they can reduce a student’s aid package by 20% of the account value.
3. Qualifying U.S. Savings Bonds
The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE and I Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.
Pros:
- U.S. savings bonds are federal tax-deferred and state tax-free.
- Series EE and I bonds purchased after 1989 may be redeemed federally tax-free for qualifying higher education expenses.
- Bond owners are investing in interest-earnings bonds backed by the full faith and credit of the U.S. government.
Cons:
- The maximum investment allowed is $10,000 per year, per owner, per type of bond.
- The interest exclusion phases out for incomes between $117,250 and $147,250 (in 2018) for married couples filing jointly or $78,150 and $93,150 for individuals.
- If bond proceeds are not spent on tuition and fees, interest earned will be included in federal income and subject to tax.
4. Roth IRA
Roth IRA is an individual retirement plan (a type of qualified retirement plan) that bears many similarities to the traditional IRA. The biggest distinction between the two is how they’re taxed. Traditional IRA contributions are generally made with pretax dollars; you usually get a tax deduction on your contribution and pay income tax when you withdraw the money from the account during retirement. Conversely, Roth IRAs are funded with after-tax dollars; the contributions are not tax deductible – although you may be able to take a tax credit of 10 to 50% of the contribution, depending on your income and life situation. But when you start withdrawing funds, qualified distributions (see below) are tax free.
Pros:
- Contributions can be withdrawn at any time for any reason.
- The normal 10% early withdrawal penalty on earnings is waived when the funds are spent on qualified higher education expenses.
- There is a broad range of investment options available.
- The value of retirement accounts is not counted as an asset on the FAFSA.
Cons:
- In 2018, the maximum investment allowed is $5,500 ($6,500 for taxpayers 50 and over).
- Only married couples earning less than $189,000 (in 2018) or individuals earning less than $120,000 may contribute the maximum amount.
- Married couples earning who earn $199,000 or more are ineligible to contribute ($135,000 for individuals).
-Withdrawals from a Roth IRA to pay for college is counted as base-year income on the FAFSA.
5. Coverdell ESA
A Coverdell ESA (Education Savings Account) is a tax-advantaged account designed to help save for educational expenses. Similar to a Roth IRA, contributions are made to a Coverdell ESA on an after-tax basis, which means that you don't get a tax deduction for the money you deposit.
Pros:
- Coverdell Education Savings Accounts (ESAs) you can take advantage of tax-free withdrawals to pay for qualified higher education expenses and also K-12 expenses.
- There are a broad range of investment options available, including the ability to self-direct your investments.
The value of a Coverdell ESA account is counted as a parent asset on the FAFSA, no matter whether a parent or dependent student owns it.
Cons:
- The maximum investment allowed is $2,000 per beneficiary per year, combined from all sources.
- Contributions have to be made before the beneficiary turns 18, and the account can only be used until they turn 30.
- Only married couples earning between $190,000 and $220,000 or individuals earning between $95,000 and $110,000 are able to contribute.
6. 529 plan
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
Pros:
- Withdrawals spent on qualified higher education expenses and up to $10,000 per year in K-12 tuition avoid federal tax, and some states offer additional state tax benefits.
- Depending on which plan you use, maximum investments can exceed $500,000 over the life of the account, and deposits up to $15,000 per year per individual will qualify for the annual gift tax exclusion.
- There’s also an option to treat a contribution up to $75,000 in one year as if it were made over a five-year period to shelter a larger amount from taxes.
- 529 plans receive favorable financial aid treatment: accounts owned by dependent students are treated as parent assets and nothing has to be reported on the FAFSA when the funds are withdrawn to pay for college.
Cons:
- Earnings are subject to income tax and a 10% penalty if the withdrawal is not spent on qualified education expenses.
- Investment strategies available are limited to what’s offered by the program.
- Withdrawals from accounts owned by someone other than the student or their parent have to be added back to the student’s income on the following year’s FAFSA and can reduce aid eligibility by as much as 50% of the amount of the distribution..