Are you trying to figure out where to save for your child's education? You are likely trying to weigh the pros and cons of all your education planning options. It is usually best to deploy a strategy that includes different account types. Using a blend of accounts can reduce the risk of unwanted penalties and taxes.
Here are the most common savings vehicles to help you save for your child's education. Here is a brief list of each of those options you may be able to use for education:
529 Saving Plans
Coverdell Accounts
UTMA/UGMA
Individual taxable accounts
EE and I Bonds
Retirement Accounts
Carefully consider the unique characteristics of each before executing an education savings plan. To get the most benefit out of these options– start early!
529 Saving Plans
529 plans are tax-advantaged savings plans specifically designed to create an investment vehicle to pay for education expenses. 529 plans are not just for college – tax-free withdrawals may also include up to $10,000 per year in tuition expenses for K-12 schools. State tax treatment of K-12 distributions varies. Although contributions are not deductible at the federal level, earnings grow federal tax-free, and there is no federal tax on qualified withdrawals to pay for college. Depending on your state, you may be able to deduct contributions from your state taxes.
All 529 plans have a plan manager, usually a financial services firm, that manages the portfolio of investments. You'll likely be able to create a portfolio from an offering of mutual funds and ETFs and tailor it to your time horizon and investment preferences. You and your spouse (and anyone else who wants to – it's not limited to parents) can contribute up to $16,000 per year each (in 2022) and still fall under the gift tax exemption.
You can fund the account with five years' worth of your annual exclusion gifts, so your child's 529 can begin with a balance of $80,000. When the funds are distributed for and used for qualified education expenses, the amount distributed is free of tax and penalties.
Coverdell ESAs
Coverdell accounts are less popular than 529 plans. But they are also a tax-advantaged account designed for assisting families in paying for education expenses. The max that may contribute to a Coverdell is $2,000 per year. This annual contribution cap can be a significant disadvantage for Coverdells compared to other options. This annual max is the total amount allowed independently of who contributed (a key difference from the 529 plan).
Coverdells do not provide a tax deduction, but the assets accumulate tax-deferred. When the funds are distributed for and used for qualified education expenses, the amount distributed is free of tax and penalties. You may use funds from the Coverdell for qualified expenses for both K-12 and university.
Contributions are subject to income phaseouts, and you may only contribute when the child is younger than 18. You must distribute all the funds from the Coverdell ESA by the child's 30th birthday.
UGMA/UTMA
For future education expenses, you may use custodial accounts opened under the Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). The adult custodian must manage the assets in these accounts for the child's benefit. And when the child reaches the age of maturity (dependent on state law), the child receives complete control of the assets. So, you may want your child to use the money for school, but if they have reached the age of maturity, it is within their power to do whatever they wish with the funds. A contributor can contribute no more than $16,000 a year to avoid gift taxes. As the custodian of this account, you also need to be careful about managing any kiddie tax. UGMAs and UTMAs do not offer any tax advantages.
Taxable Accounts
An individual or joint brokerage account owned by you, the parent(s), can be a great way to save. There are fewer rules than 529 or Coverdell accounts with a taxable account. Maybe you would like this kind of account because there is more flexibility. Because these are not tax-preferred accounts, you won't face the penalties associated with 529 or Coverdells for not using the funds for qualified expenses. Furthermore, you retain control of the account even after the child has reached the majority age. You are the account owner, after all. But there are no special tax breaks. However, you can manage tax exposure in these accounts with low-cost tax-efficient investment options and tactics.
Are you trying to figure out where best to save your hard-earned money? Download our 18-point checklist, which outlines the accounts you should consider if you want to save more.
EE and I Bonds
EE and I Bonds are bonds sold directly for the US Treasury. These bonds accrue interest, and you can avoid taxes if you use the interest earned from the bond for qualified higher education expenses for a dependent or child. However, if your income is higher than a specific limit, you may still owe taxes on the interest used for qualified expenses. Carefully review the interest rates offered on these bonds, as sometimes the rates are competitive, and sometimes they are not.
Individual Retirement Accounts
You can use retirement accounts for qualified education expenses. However, it is not usually where you want to pull funds for education. Before your begin to plan on using your retirement accounts for your children's education, you need to make sure you are saving enough and will have enough for retirement. The unfortunate truth is you cannot borrow money for retirement. However, your child can borrow money for their education. I have seen some scenarios where, with proper planning, it makes sense to use retirement accounts for education. But this requires careful consideration as taxes and penalties can be involved if not correctly executed.
The Takeaway
You can set up your accounts and plans as soon as there is a little person to benefit from them, so starting before the child's first birthday is ideal. The sooner you begin saving for your child's education, the better. A financial planner can assist you in setting these up and selecting appropriate investments based on your time horizon and goals.
Working with a trusted financial advisor can reduce your stress and help you map out the best course of action for your situation. Are you trying to figure out what savings strategy is best for your child's education? At Pursuit Planning and Investments, LLC, I help you think through your options. I ultimately help you make the best decisions for yourself, your family, and your money. Feel free to place a commitment-free 30-minute meeting on my calendar. We can discuss your goals and begin best optimizing your financial plan in that meeting.
Have something on your mind?
This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.
Pursuit Planning and Investments, LLC (“PPI”) is a registered investment advisor offering advisory services in the State of Oregon and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Past results do not guarantee future results. Please contact us at 971-803-5948 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from PPI with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on our website, www.planyourpursuit.com. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.
This communication is for informational purposes only and is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This communication should not be relied upon as the sole factor in an investment making decision.
Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal the performance noted in this publication.
The information herein is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Pursuit Planning and Investments, LLC (referred to as “PPI”) disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose.
All opinions and estimates constitute PPI’s judgement as of the date of this communication and are subject to change without notice. PPI does not warrant that the information will be free from error. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall PPI be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided herein, even if PPI or a PPI authorized representative has been advised of the possibility of such damages. Information contained herein should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.
Comments