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Throughout this series, we talked about some of the most common education savings vehicles for saving for college—also known as savings vehicles.
Savings vehicles are accounts that are used to save money, such as certificates of deposit (CDs) and savings accounts. Some savings vehicles are specifically designed for saving for education, such as 529 plans and ESAs. If you want to start saving for college for your child early on, these savings vehicles can help you invest money in your child’s future education.
In this chapter, we’ll talk about how you can choose the right savings solution for your family. We’ll discuss short-term, mid-term, and long-term options that can help you cover the cost of school expenses when your child goes to college. After reading, you should have a better idea of what the next step is. Use the links below to navigate the article.
- What Is a Savings Vehicle?
- What Are the Main Types of Savings Vehicles?
- What Are the Most Important Factors to Consider?
- Best Options for Short Term Savings
- Best Options for Mid Term Savings
- Best Options for Long Term Savings
- How Can I Make Money from Savings?
What Is a Savings Vehicle?
A savings vehicle refers to an account that’s specifically designed for people who want to save a portion of their income. There are different types of savings vehicles geared toward specific purposes, including education savings vehicles that can help you save for college.
In this chapter, we’re focusing on education savings vehicles, which includes things like 529 plans and Coverdell ESAs. Education savings vehicles typically include benefits such as tax advantages that help with college savings, but each type of savings vehicle is different from the next.
The most notable benefit of savings vehicles is that some of them offer tax-free earnings when you use the money to cover qualifying education expenses. If the money is used for non-qualifying expenses, withdrawals will be taxed. By investing in these accounts and learning how to budget, you can start saving money for your child’s college early on.
What Are the Main Types of Savings Vehicles?
Understanding the different types of education savings vehicles can help you choose the right solution for your family. There are three types of savings vehicles that are specifically designed to cover education expenses: 529 plans, ESAs, and UGMA/UTMA accounts. Let’s do a quick refresher—for a deep dive, go back through the previous chapters in this series.
- 529 Plan: A 529 college savings plan is one of the most popular options when saving for college. The money you contribute to a 529 plan grows tax-free, and annual withdrawals up to $10,000 are tax-free if the money is used for qualifying education expenses. 529 plans can cover college expenses in addition to qualifying K-12 education expenses. With no contribution limits, age limits, or income limits, 529 plans are one of the most accessible savings vehicles for education.
- Coverdell ESAs (education savings accounts) are another popular choice for college savings. ESAs are similar to 529 plans in the sense that withdrawals are tax-free as long as the money is used for qualifying expenses. However, ESAs are only available to families below a certain income threshold, and yearly contributions are limited to $2,000 per child. That being said, ESAs are still a good way to save for college.
- You can also start a UGMA or UTMA account to save for your child’s college. A UGMA or UTMA account allows you to gift up to $16,000 per year in assets which are then held in a custodial account until your child turns 18. These accounts aren’t just for education, which means your child can spend their earnings on other expenses. However, gifting a UGMA or UTMA account is different from 529 plans and ESAs because withdrawals aren’t tax-free, even if they’re used to pay for college.
However, you can also use other investment accounts to save for college. For example, Roth IRAs allow you to contribute money that can grow tax-free and be withdrawn tax-free. Consider talking to your financial advisor about starting a Roth IRA and whether it’s the right option for you.
What Are the Most Important Factors to Consider?
When you’re choosing between the various education savings vehicles, there are several important factors to consider.
When You’ll Need the Money
The first thing you should consider is when you need access to the money you’re investing. With UGMA and UTMA accounts, your child doesn’t have access to their account until they’re 18. If your child goes to college before they’re 18, or if you want to use that money for K-12 education expenses, you’re out of luck. With a Roth IRA, you can’t make a tax-free withdrawal until it’s been five years or more since your first contribution.
Types of Assets You Want to Include
Different savings vehicles allow you to invest in different types of assets. For example, UGMA accounts are limited to financial assets, while UTMA accounts include both financial and physical assets. While 529 plans are handled by an investment advisor, ESAs can be self-directed and offer a broader range of investment opportunities. Consider this when you’re choosing an investment account.
Where You Live
Your location is another important factor when you’re choosing a savings vehicle. While some states may offer tax breaks for 529 plan contributions, others don’t. If you’re in a state that doesn’t offer tax breaks for contributing to 529 plans, you might want to consider another education savings vehicle.
Best Options for Short Term Savings
If you’re looking for a short-term college savings option, Roth IRAs are one option you may want to consider. With Roth IRAs, you must wait at least five years before making tax-free withdrawals, so consider starting a Roth IRA when your child is 13 or younger. Roth IRAs are only available to people in certain income brackets, and you can contribute a maximum of $6,000 per year.
Prepaid tuition 529 plans may also be a smart choice if you want to help your child save for college. By purchasing college credits at their current price for later use, you can save on college expenses if the per-credit cost increases in the future.
You might not be able to cover all of your child’s college expenses, but prepaid tuition plans can make college a more realistic option. If you choose a prepaid tuition plan, consider calculating the cost of living for your college student without tuition costs.
Best Options for Mid Term Savings
ESAs, or education savings accounts, are specifically designed for saving for college. These accounts allow your child to make tax-free withdrawals as long as they’re using the money for qualifying expenses, but you can only contribute up to $2,000 per child, per year. Not only that, but you can only contribute to an ESA until your child turns 18, so they may not be the right option for you. We cover ESAs more in depth in Chapter 4.
529 plans are similar to ESAs, only they don’t have any of the limits that ESAs have. With a 529 plan, you can contribute money that grows tax-free, and your child can withdraw account earnings tax-free as long as they’re used to pay for qualifying education expenses. Even if you start a bit late, 529 plans can still help you save. We cover 529 plans more in depth in Chapter 5.
Best Options for Long Term Savings
529 plans often provide the most benefit if you get started early because your child can withdraw up to $10,000 per year tax-free. This money can be used to cover expenses like tuition and room and board. The earlier you start, the more you can typically expect to save with a 529 plan.
ESAs also tend to work best when you start early because of the contribution limits. At $2,000 per year, it may take a while to build up a significant ESA, but ESAs can be a useful tax-advantaged investment option if you start early.
UGMA and UTMA accounts allow for large annual contributions, which might be a significant advantage to some people. The biggest downfall with UGMA and UTMA accounts is the fact that withdrawals aren’t tax-free and these accounts can have a major effect on financial aid eligibility. We cover UGMA and UTMA accounts in more depth in Chapter 7.
How Can I Make Money from Savings?
If you want to try to make money from savings, investing is the first step. The more money you save, the more your money can grow with a savings vehicle. Growing your money with savings vehicles isn’t just about preparing your child for college; advantageous investments can also help when it comes to managing money after college.
The Bottom Line
The most popular education savings vehicles include 529 plans, Coverdell ESAs, UGMA and UTMA accounts, and Roth IRAs. The savings vehicle you choose will determine you and your child’s tax liability, as well as how much you’re able to contribute annually.
From ESAs and 529 plans to Roth IRAs, we’ve covered the basics of education savings vehicles. If you have more questions or need help deciding how to save for college, you may want to consider speaking with a financial advisor.
This concludes our saving 4 college series. You can always go back and read the previous chapters if you need a refresher on anything or want to bookmark this guide and come back to it when you’re ready to make a decision.
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