College finance – How to save
By Isabelle Denton
The most popular way to save for college is a traditional savings account, according to a survey by Sallie Mae. That is a shame, considering the number of other vehicles out there offering benefits above and beyond the conventional account.
Saving for college can have a sizable impact on a family’s financial plans, so think through how much you are willing and able to contribute to college finances. Keep college costs in perspective with your other financial goals – led by retirement – as well as other funding resources for college.
Read more:
College Finance – How much to help
Once you have decided how much to save, consider the investment vehicle or combination of accounts that benefit your family the most. Here are some common options:
Tax-deferred saving for education
A 529 savings plan, the second most commonly used account for college savings, is a great option for those specifically setting aside money for a child’s higher education. The main benefit is that all distributions, including earnings, are taken tax free if used for a qualified education expense. (Since 2018, qualified expenses have included some primary and secondary school expenditures.) Bonus: If the child for whom the account was established does not use it, another family member can use it for their education expense. Otherwise, if the money is withdrawn for another purpose you could face taxes on earnings and a 10% penalty.
Coverdell accounts also offer additional benefits for college savers but come with a lower contribution limit of $2,000 per year. A Coverdell account also allows distributions for primary, secondary and post-secondary education expenses. Like the 529 savings plan, any funds withdrawn for qualified education expenses are tax free. To make contributions, there is an income limit of $110,000 if you are single and $220,000 if you are married.
Saving for college and retirement
What if you save for a child’s college education and the child ends up not needing the money or not going to school altogether? A good way to hedge that risk would be to save through a Roth IRA. If you end up not using the money on an education expense, it will leave more available for you in retirement.
With a Roth IRA, you can withdraw your principal, any amount that was contributed, without penalty or taxes at any time. You can also withdraw earnings without the penalty, as long as the proceeds are going toward a qualified education expense.
Otherwise, earnings can be withdrawn penalty- and tax free after you reach age 59½.
A Roth IRA will not be counted as an asset when determining financial aid eligibility. However, any withdrawals to cover college expenses will show up as income to the student the following year, potentially affecting aid considerations.
Saving for child, not necessarily for education
Many parents and grandparents choose to save for education through a custodial account such as a UTMA (Uniform Trust to Minors Act) or UGMA (Uniform Gift to Minors Act).
Although there are no contribution limits, the current gift tax exclusion rate is $14,000.
A possible downside to these accounts is that once the child reaches the age of majority, they are allowed to take control of the funds and do not have to necessarily use it for education purposes.
These funds count as the student’s assets when being considered for financial aid, which could affect their eligibility for certain grants and loans.
Since everyone’s savings goals are different it’s important to review all options available to you to determine what works best for you and your family. These are a few of the many tools available for college savings. Click here to see a more detailed breakdown of college saving vehicles as well as links to other resources.
Isabelle Denton is a registered representative and investment advisor with Landaas & Company.
(initially posted May 22, 2015; updated 2019)
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