Setting aside funds for higher education can create a brighter future for you or a loved one, but deciding how to go about investing can leave you guessing. If you are setting aside funds specifically for education – then with any account growth vehicles like 529 college savings plans and Coverdell Education Savings accounts offer tax-deferred or even tax-free growth so you can maximize your potential savings. Whichever approach you select, it’s important to remember that starting early and contributing even just a little bit can help you reach your goals faster.
There are a number of choices available for those seeking tax-efficient accounts specific education. These include 529 college savings plans, Coverdell Education Savings accounts, and UGMA/UTMA Custodial accounts.
Sponsored by individual states, these college savings plans offer a level of flexibility and potential tax advantages that can make them a great choice for the right investor. Benefits of a 529 plan vary from state to state.
These accounts offer federal tax-free earnings and withdrawals on qualified expenses such as tuition, books, computers, and room & board. While 529 Plans are used exclusively for college. Coverdell Education Savings Accounts (ESAs) can be used for elementary and secondary schooling in addition to college. Additionally, there are no minimum contributions, and account owners can contribute up to $2,000 per child per year. See if Coverdell ESAs are right for you by exploring more account details.
Custodial accounts provide a way to build assets for your children or loved ones future, and let you manage a minor’s assets for their benefit. As you build a portfolio, with or without assets from the minor, you will be the guardian of the account, managing it until the minor reaches the age of majority. From the start, the account will be held under the minor’s name and Social Security Number. Once they are old enough they will assume control of all assets.
Learn more about the tax benefits and details of custodial accounts.
Some states offer an alternate 529 plan that allows you to prepay tomorrow’s college tuition at today’s prices to attend an in-state college. Some plans cover tuition, fees, and room and board, while others only cover tuition and fees.
529 Plans | Coverdell ESAs | UGMA/UTMA Custodial Accounts | |
|---|---|---|---|
Is there a contribution limit? | Yes (Varies by state) | Yes ($2,000 per year) | No |
What’s included in “qualifed expenses”? | Tuition, fees, books, school equipment, school supplies, room & board for college only | Tuition, fees, books, school supplies, room & board for all levels of education | Any costs that benefit the minor for education-related or other costs |
Are qualified expenses taxed? | No (Federal tax-free, State taxes may apply) | No (Federal tax-free, State taxes may apply) | Yes (Investment income is subject to federal income tax, possibly at child rate) |
Can you change the beneficiary? | Yes | Yes | No |
Are there any income limit restrictions? | No | Yes (Ineligible if your Adjusted Gross Income is $95,000-$110,000 for single filer; and $190,000-$220,000 for joint filers | No |
How is the account treated for estate tax purposes? | The value of the account is removed from the account owners taxable estate | Contributions are treated as completed gifts from the contributor to the beneficiary | The value of the account is included in the custodian’s taxable estate |
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Before rolling over a 401(k) to an IRA, be sure to consider your other choices, including keeping it in the former employer’s plan, rolling it into a 401(k) at a new employer, or cashing out the account value. Keeping in mind that taking a lump sum distribution can have adverse tax consequences. Be sure to consult with your tax advisor.
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