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Chapter 3: Saving for College for Your Child

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In this chapter, we’ll talk about when you should start saving for your child’s college education and what you can do to get started. Saving for college for your child is a big step in planning for your financial future, so we’ll cover everything from your available options for saving for college to getting a financial advisor involved.

This chapter will help parents save by talking about what college savings options are available, including 529 plans, ESAs, and UGMA/UTMA accounts. We’ll also discuss when you should start saving, how to start a college fund, when you might consider getting a financial advisor involved, and other college saving tips to help parents who are taking on this major life goal.

What Are the College Savings Options Available?

Before you can start saving for a child’s college education, you need to understand the college savings options that are available to you. Your primary options are 529 plans, ESAs, and UGMA/UTMA accounts. We’ll talk more about each of these savings options later on in the series, but we’ll provide a brief description of each savings option and how it works.

529 Plans

Starting a 529 account is one way to start saving for a child’s college education. A 529 plan is a tax-advantaged investment account that’s specifically designed for saving for higher education expenses. The tax benefits of a 529 plan are only available if the funds in the account are used to pay for qualifying education. This may include K-12 tuition, apprenticeship programs, and student loan repayments.

The tax breaks that come with 529 plans are perhaps the biggest benefit. The money you invest in a 529 plan isn’t taxed federally when it’s used to pay for qualifying education expenses, which means your investment goes a lot further. Some states even offer tax breaks for 529 plans, which helps you get even more out of your investment.

There are no income limits, age limits, or annual contribution limits with 529 plans, so they’re an accessible way for parents to save for college. However, there is a contribution limit that applies to contributors for 529 plans. For the 2022 tax year, contributions over $16,000 per individual will be subject to a gift tax. 

ESAs

ESAs, or education savings accounts, are another form of tax-advantaged investment account designed for people saving for future education expenses. Like 529 plans, the earnings from ESAs can be withdrawn tax-free as long as the funds are used for paying for college or other qualifying education expenses. If distributions are higher than education expenses, the earnings will be taxed at the account holder’s tax rate.

Like 529 plans, ESAs can be used to pay for higher education as well as primary and secondary schooling. However, it’s important to make sure you’re using ESA earnings to pay for qualifying education expenses, or the tax break may not apply to your distributions.

Unlike 529 plans, ESAs do have income limits. You can’t contribute to an ESA if you make more than $110,000 if you’re filing single, or $220,000 if you’re married filing jointly. There are also contribution limits; you can only contribute up to $2,000 per year, per child. As we mentioned before, any withdrawal for non-qualified expenses is taxed.

UGMA/UTMA Accounts

UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts are actually considered custodial accounts because they’re in the name of a minor but controlled by a parent. These accounts are controlled by parents until their child reaches the age of majority, which is typically 18 but may vary in some states. With a UGMA or UTMA account, you can save and invest money in an account in your child’s name and maintain control of the account until they’re an adult.

As far as taxes go, UGMA and UTMA accounts are a bit different than ESAs and 592 plans. With these accounts, you contribute after-tax dollars, which are taxed at varying rates. The first $1,150 in earnings are tax-free, the next $1,150 is taxed at the child’s tax rate, and any earnings above that amount are taxed at the parent’s tax rate.

It’s also important to consider the impact UGMA and UTMA accounts have on qualifying for financial aid. Unlike 529 plans, UGMA and UTMA accounts can have a significant impact on your child’s FAFSA eligibility because they’re considered your child’s asset, which means their financial aid is reduced by 20% of the account’s value. That being said, these accounts can still be a good way to save for a child’s college expenses.

Investment Accounts Can Also Be Used

In addition to 529 plans, ESAs, and UGMA and UTMA accounts, you can also use other types of investment accounts to save for your child’s college expenses. For example, you can contribute after-tax dollars to a Roth IRA, which is typically used as a retirement account and withdrawn at the age of 59. However, a Roth IRA also allows the beneficiary to withdraw funds for college without paying any taxes. Most investment accounts, including Roth IRAs, do have income limits and contribution limits, so consider that when you’re deciding on the right investment account.

Of course, there are pros and cons to using investment accounts when saving for college for a child. Contributions limits may affect the amount you can contribute to your retirement. Even if your child has turned 18, Roth IRA earnings are subject to a five-year holding period. Still, these investment accounts can offer tax-advantaged options for saving for college for a child. 

When Is the Best Time to Start Saving?

If your child is still young or you’re an expecting parent, you’re probably wondering how early is necessary to start putting funds away—especially when you consider the costs of raising kids. So, when should parents start saving for college?

The earlier you learn how to start a college fund and start saving for college for a child, the more you can potentially put away for their higher education. This is especially true if you’re using an investment account..

Of course, it’s important to keep in mind that everybody is in a different situation financially, and not everyone can invest right away. Even if you’re only able to put away a small amount, getting started early on can give you time to plan and adds up over time. You can also start small and then increase your contributions as your income increases.

There are a lot of resources online about how to save for a child’s college education, and you can even get help from a professional.

Get a Financial Advisor Involved in Plan

Speaking of professional help, you might consider getting a financial advisor involved to help you save for your child’s college expenses. A financial advisor can help you understand the pros and cons of the different college savings options, including traditional investment accounts. Financial advisors can also help you take everything into account—including factors like your cost of living and inflation—so you can make more informed decisions.

If you’re not sure how to start saving for college for your child, talking with a financial advisor might be an option to consider. Keep in mind that financial advisors charge fees that are often a small percentage of what your investment accounts earn.

5 College Savings Tips for Parents

The idea of saving for your child’s college expenses can be overwhelming, but taking small steps will get you closer to your goal. Here are 5 college savings tips that can help you start saving for your child’s college:

  1. Consider a 529 college savings plan: 529 plans offer considerable tax benefits and have no income limits or contribution limits.
  2. Get started early: The earlier you start, the more time your investment will have to grow.
  3. Invest what you can afford: Don’t invest more than you can afford. This can put you in a difficult financial position that can have a ripple effect on your future.
  4. Use windfalls: One option is to use bonuses, tax refunds, and other large sums of money to help bolster college savings for your child.
  5. Get help from relatives: If you can’t invest your contribution limit, consider getting help from relatives as a birthday gift for your child to make sure you’re investing as much as possible.

In Conclusion

Now you know about the basics of saving for college for a child—from 529 plans and ESAs to traditional investment accounts—you might consider discussing these options with a financial advisor to figure out what’s best for you and your family. The earlier you can start investing in saving for your child’s education, the more time you’ll have to prepare and adjust your plan accordingly to help ensure they can afford higher education.

Need help tracking your savings? You can also use the Mint app to see all of your finances—including your college savings fund—in one place.

In the next chapter, we’ll take an in-depth look at ESAs (education savings accounts), including how they work, the pros and cons, and the differences between an ESA and a 529 plan. Take the next step in finding the right college savings account for your family.

Sources: California Society of CPAs | IRS

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