Depending on the number of children you have, paying for college could be the largest investment you ever make. That said, careful planning, and research into the best saving options available could save you a lot of stress and save your child from the burden of excessive student loans. What kind of saving options are available? Below is a list of the most common tools parents use to save money for their child’s education:
1. 529 Plans. Named for the IRS tax code that applies to them, 529 plans are investment accounts that you can contribute to and grow tax-free. Specifically, you invest your after-tax income in a 529 investment account and let it grow until your child reaches college age. Then you withdraw your funds tax-free and use them to pay for your child’s college costs. These are not state specific. You can live in MI, contribute to a 529 plan out of CA and send your child to a school in WA and still use the money you have saved.
One advantage of 529 plans, aside from the tax-free withdrawal, is that many companies and credit cards provide benefits and shopping rewards for using their services that can be deposited into the 529 account.
2. IRA or Roth IRA. This is a means of using the retirement account you already have to save for college. You can contribute additional funds to your IRA to use later for college costs. However, there can be tax penalties for withdrawing money out of an IRA that do not apply to some other plans, including most 529 plans.
3. Prepaid tuition plans. Many states allow you to prepay for college tuition at the current rates. This, of course, gives you the benefit of paying for college at a lower cost than it will be when your child attends school. However, these plans are state specific. If you prepay for college in Alabama, your child must attend an in state school in order to use the full benefit. If your child does choose to go out of state you do lose your contributions, but you could end up paying the difference between the average cost of tuition in your home state and that of the state where your child attends school.
4. Coverdell Education Savings Accounts. These function nearly the same way as retirement accounts, but they are designed specifically to be used for college expenses. This means that some of the tax penalties applied to an IRA would not apply to these accounts, even though they function in the same way otherwise.
5. Custodial Savings Accounts. These accounts are typical savings accounts in most ways. You set up an account for your child and will be the custodian on the account until your child reaches 18 or 21 years of age. Then the funds in the account go to your child. You control how much money you deposit into the account, and how it is invested. One advantage to this type of account is that the first $850.00 contributed each year is not taxed as part of your savings.
6. Traditional Savings Accounts. This is an account you set up in your name and contribute money to, with the intent of using it for your child’s college tuition. These accounts do not carry the same benefits as many of the other types of savings plans, but they are entirely under your control from the outset.
7. Tax Credits. This is not a savings plan or account, but worth noting. There are several federal or state tax credits that you or your child could qualify for based on their college expenses. That said, many of the savings plans, since they are tax-free, disqualify you from receiving these credits. One tip is to pay for only a portion of the yearly expenses with money from one of the savings plans above and accept a loan for the remainder of the costs. That way you will still qualify for the tax credits and can apply those directly to the loan.
There are many tools available to parents to help plan and save for the college expenses of children. Taking advantage of the tax breaks, and the dedicated college savings plans could prevent some of the stress of paying for college when the time comes.