Saving for College
Start Early, Save More
Planning for college is not something that begins when a student is in the junior or senior year of high school. In fact, it’s something that may even happen while they are still in diapers. Given the ever-rising costs of an education, it has become a common practice for parents to begin saving for a college education while their children are still very young and in some instances before they are even born. There are many ways in which parents and students can set aside funds to off-set the significant cost of attendance.
Savings Account
The most obvious thought that comes to mind when considering saving money for a future investment is to open a basic savings account. Money is deposited and depending on the bank / institution, some return on this investment is made through interest and time.
Given that same basic principle there are several programs, each with their own benefits and incentives that may also assist in saving for a future education.
U.S. Treasury Savings Bonds
The U.S. Treasury Bond is one of the most secure savings programs because it’s fully backed by the Federal Government. Although it typically earns lower interest rates than other forms of saving programs, you get the added benefit of being tax exempt. The tax exemption applies to federal income tax as well as state and local taxes, provided the funds are used to pay for qualified educational costs.
Custodial Accounts
A custodial account is an account that is created and managed by an adult for a minor that is under the age of 18 to 21 (depending on state legislation). Any and all deposits into this account become the permanent property of the beneficiary. Typically with a custodial account, the custodian is the parent or legal guardian of the minor.
Qualified Tuition Plans (QTP): Also known as plan 529, after the section of the IRS code that provides the plan's special tax breaks, QTP are prepaid tuition or savings plans.
Prepaid tuition plans: In essence allow parents (or anyone) to purchase tuition to a school today (at today’s rates) for use in the future, regardless of future interest rates or tuition fluctuations. QTP interest is not taxed as it accumulates, nor is it taxed at the time of use, so long as the disbursement does not exceed the cost of attendance.
College savings plans: Rather than prepay, participants save funds that are to be used for college expenses. This program can be used at most accredited post secondary institutions.
Some states offer one plan or the other, while other states offer both plans. (Some plans allow participants to use funds for accredited vocation and international colleges.)
Coverdell Education Savings Accounts (ESAs)
Coverdell ESAs work much in the same way as a Roth IRA account, however instead of saving for retirement, ESAs are used to save for education. The Coverdell ESA allows you to make an annual non-deductible contribution to a specially designated investment trust account that may be set up for beneficiaries under the age of 18, or those with special needs. Friends and family may deposit money into the account, but the total contributions for the year may not exceed $2,000. As with Qualified Tuition Plans, the earnings on the account accumulate tax free. Additionally, withdrawals from the account will not be taxed so long as the disbursements do not exceed the cost of attendance.
Withdrawing from a Retirement Account
Typically, withdrawals made from an Individual Retirement Account (IRA) before a certain age are subject to penalties. However, it is important to note that this penalty is waived if the withdrawal is made to pay for a qualified education expense. Income taxes may still apply on earnings so you may want to consult with your tax advisor for details.
