Recently, I wrote about 529 plans and why they can be a good way to save for college. 529 plans are the most common savings accounts that are directly geared towards educational spending. While 529 plans have tax-free disbursements and can be used for tuition, fees, college expenses, room and board, they are not the only college savings accounts. Here are some alternatives to the traditional 529 plan that you may want to consider, and why you should consider them.
What makes the 529 a more popular college savings plan?
The biggest advantage to the 529 is the tax advantage, and the money grows tax deferred. Withdrawals are also tax-free as long as funds are used for qualified expenses. In addition, many states have a tax deduction or credit for contributions.
Why look at an alternative to a 529 college savings plan?
Money in a 529 can only be used for qualified education expenses. Otherwise, you have to pay a penalty to get the money back. Plans are limited to one beneficiary, however the owner of the account can designate a new beneficiary if the funds are not fully used for education by the original beneficiary. The tax benefits continue for the remaining funds in the account as long as they are used for qualified education expenses of the subsequent beneficiary. If a student is unsure if they want to pay for college, a 529 plan may not be the best option.
What is a Prepaid Tuition Plan?
The prepaid tuition plan is a subtype of the 529 plan. This allows you (whether you are a parent, grandparent, or other relative) to pay for future tuition at current rates. This can possibly result in savings, since tuition has been rising at 8% year-over-year. However, some states put a cap on the balance in the account. Another downside is that these plans are limited to certain institutions within the state. This means that a student’s choices of where to attend college can be limited. The other difference between the prepaid tuition plan and the regular 529 account is that this plan is only for tuition, so you cannot use the funds to pay for expenses like room and board. We usually see this type of account as being the most useful if a parent is certain of where their child will attend college.
How is a Coverdell Education Savings Accounts (ESA) different from a 529 plan?
The Coverdell Education Savings Accounts also allows students to take tax-free distributions for qualified education expenses, just like a 529. Furthermore, the ESA provides a larger scope of investment options than most 529 savings plans. However, there are disadvantages to the ESA. First, the funds contributed are not eligible for tax deductions or credits. The contributions are also limited to $2,000 annually and the modified adjusted gross income (MAGI) cannot exceed $220,000 for married couples or $110,000 for single filers. This puts more limitations on who can open an ESA than a 529.
How does a custodial account like a UGMA or UTMA work for college savings?
A custodial account like a UGMA or UTMA can be useful if parents are uncertain as to whether their child will attend college. They are for the benefit of a child, but the money in the account does not have to be used specifically for college. A UGMA or UTMA allows the account holder more discretion on investments and the use of funds. For example, like a Coverdell ESA, the investment options are mostly unlimited. However, custodial accounts do not provide the tax benefits of 529 plans. The funds contributed aren’t eligible for tax deductions or credits and the earnings are taxable. If the beneficiary of the account does end up using the funds for college, there can also be a downside. On the Free Application for Federal Student Aid (FAFSA), up to 20% of the balance of a UGMA or UTMA account can be counted towards their assets, while only 5.64% of the 529 balance counts towards assets. A student with $20,000 in a UGMA or UTMA could receive less financial aid than a student with the same amount in a 529 plan.
Although there are a number of options for college savings, one of the best things to do is to start saving early. The sooner you understand what college costs and what the options are to paying for it, you can make more informed decisions. Don’t hesitate to contact our office with any questions about your financial future.
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