One of the best personal finance tips for the well-being of your children’s future is to start saving for university or college now.
After all, university or college education can be expensive and more and more graduates finish schooling with significant amounts of student loan debt.
According to an analysis of government data by Mark Kantrowitz, publisher at Edvisors, a group of websites about planning and paying for college, the average class of 2015 graduate with student loan debt will have to pay back a little more than $35,000.
Even adjusted for inflation, it’s still more than twice the amount borrowers had to pay back two decades earlier.
Many parents want to help their kids save for college education but sometimes they don’t know where to begin.
Today, we provide five ways you can start saving for university or college for your children’s education.
529 College Plans
You can start saving for university or college with a 529 college plan.
A 529 plan offers tax advantages and other incentives to make it easier to save for college for a designated beneficiary such as a child or grandchild.
Generally, you put your after-tax money into the plan. You’re then allowed to withdraw the funds as well as any investment gains tax-free for use toward qualified education expenses, such as college tuition and books.
529 plans can vary from state to state. Each state’s plan offers various investment options, annual fees, and operating costs. Therefore, make sure to understand your state’s plans details properly before making the investment.
If your child doesn’t end up going to college, you may face fees and tax penalties when you withdraw the funds. However, you can often transfer the account to another beneficiary.
Generally, you can begin to make contributions in small increments, but depending on the specific 529 plan, you may only be able to make a change to your account once a year.
You can also use a Roth IRA as a college savings investment.
A Roth IRA is an individual retirement savings account which allows your money to grow tax-free. Like the 529 plan, you put your after-tax dollars in a Roth IRA and any investment gains can be withdrawn later tax-free, most often, after age 59-1/2, for retirement.
A Roth IRA also allows you to withdraw your money tax as well as penalty free to pay for qualifying educational expenses after five years.
You can also take out funds from a Roth IRA without penalty to make a down payment on a house.
So, if your children don’t go to college you can still use the funds from your Roth IRA for your retirement.
However, there are income and contribution limits. For example, single taxpayers who earn more than $131,000 per year ($193,000 for married couples) are not eligible. Also, you can only contribute $5,500 per year ($6,500 if you’re over age 50).
Saving for University or College with Prepaid Tuition Plans
These plans allow you to pay for a portion of your child’s college tuition now at current prices, which means you are protected from exponential tuition hikes if your child is still many years away from attending college.
Like 529 plans, prepaid tuition plans are usually exempt from federal taxes.
Several states offer prepaid tuition plans, however, some are currently closed for new enrollment. Therefore, make sure to research the specific plan in your state first.
Coverdell Education Savings Account
A Coverdell Euducation Savings Account (ESA), like the 529 plan, is generally tax-advantaged if the money is used to pay for educational expenses.
Unlike a 529 plan, Coverdell ESAs can be used to cover any educational expenses, including kindergarten to grade 12 costs such as private school tuition.
However, there are some contribution limits. For instance, you can only contribute $2,000 per year per child, and eligibility starts to get reduced for couples earning more than $190,000 a year ($95,000 for singles).
If the funds from this account are not used by the time your child turns 30, the amount may be subject to taxes.
Custodial Accounts for Saving for University or College
You can use custodial accounts as an option for saving for university or college for your children.
These types of accounts, where financial gifts to a minor are held in a custodial account until the child reaches adulthood, offer some tax benefits, but fewer than 529 plans.
Also, unlike the other saving options, custodial accounts can also be considered your child’s asset, not yours, which means they can affect the amount of federal aid your child qualifies for when filling out the FAFSA.
Do thorough research about each of the above mentioned options before deciding which plan(s) may be a suitable choice for saving for university or college for your children.