By Jay Fran
With higher education costs increasing at double digitpercentages an effective college savings plan for your kid'seducation is becoming much more critical. Most parents will findthat their kid's future college costs will be much more thanthey have planned. This leaves many kids to be faced withobtaining financial aid to compensate for a portion of theirhigher education costs. This article will explore the pros andcons of 4 common college savings options. This article will alsoseek to show which of these 4 options are a better option ifpart of your kid's higher education costs are to be funded byfinancial aid.
529 College Savings Plan: Since January 2002, 529 collegesavings plan have become a new option for achieving tax freecollege savings. These plans are state sponsored investmentprograms that offer special tax treatment. It allows just abouteveryone to save for their kid's college education. While thereare many benefits of a 529 college savings plan, perhaps themost important is that your investment earnings are tax deferredif you use the funds for qualified education expenses.Additionally, another big advantage is that the maximum amountyou can contribute to a 529 savings plan can go as high ashundreds of thousand dollars but be aware these are based onyour States specific guidelines. If for some reason you do notuse the investment funds for college, you can still withdrawalyour investment earnings, but you will have to pay a federalpenalty of 10% and federal income taxes on your earnings. Thepenalty can be waived if your child receives a collegescholarship, or in the event your child becomes disable ordies.
A 529 plan can typically be easily purchased through aninvestment broker or mutual fund company like Vanguard orFidelity. Please be aware that one of the biggest disadvantagesof a 529 plan is that investment options can sometimes belimited. However, as 529 plans become more popular it is likelythat more plan options will open. For instance, the State ofOhio just announced the option for bank CDs and saving accountsfor 529 plans. One last main advantage of a 529 college savingsplan is that the money in the plan is classified as a parentsassets so less that 6% of the value counts against your kid'seligibility for financial aid.
Coverdell Education Savings Account (CESA) (formerly known as anEducational IRA): A Coverdell Education Savings Account is asavings account created as an incentive to help parents andstudents save for higher education expenses. A CoverdellEducation Savings Account is easy to set up at most financialinstitutions and banks. A Coverdell Education Savings Account issimilar to a 529 college savings plan, but different in thecontribution limits. With a Coverdell Education Savings Accountyou can only contribute $2000 per child per year and to qualifyyour adjusted gross income must be less than $110,000 if you aresingle and less than $220,000 if you are married filing jointly.For financial aid eligibility a Coverdell Education SavingsAccount is classified as a parent's asset so less that 6% of thevalue counts against your kid's financial aid eligibility.
UGMA/UTA Custodial Account (Uniform Gifts to Minors Act/UniformTransfers to Minors Act): A UGMA/UTMA account allows someone tomake gifts to a minor without setting up a trust. While thereare benefits to a UGMA/UTMA account the first limitation is thatthese types of accounts offer very little federal tax advantage.Secondly if your child is 14 or under only the first $800 ofincome is tax free, the next $800 is taxed at your child's taxrate and after that there is no tax benefit at all. The otherbig disadvantage is that an UGMA/UTA Custodial Account has to beset up in your child's name. This can create a big problem ifyour child needs financial aid since all of the assets will bereviewed at a 35% rate. As a result, a UGMA/UTA CustodialAccount is not advisable for those who may need to qualify forfinancial aid eligibility.
The main advantage of a UGMA/UTA Custodial Account is that thereis no limit on the investment contribution and it is very easyto set up at most major financial institutions including someinsurance companies. However, as can be seen above thedisadvantages of a UGMA/UTA Custodial Account far outweigh thebenefits.
Taxable Investment Accounts: Taxable investment accounts can bea broker account, a mutual fund, a certificate of deposit orjust a regular savings account. Essentially it is just a regularaccount that earns taxable interest, or investment income. Abenefit of a taxable investment account if set up in the parentsname is that the assets are classified as a parent's asset sothey do not count as a negative in the financial aid formula.Additionally, taxable investment accounts offer lots offlexibility, and are easy to set up at any financialinstitution. However, the big limitation to taxable accounts insaving for college is that they offer no tax advantage forcollege savings.
In summary, a solid savings plan for college is a very importantundertaking for parents to consider. The above 4 educationinvestment options can be highly useful in the college planningprocess. Furthermore since some of these investments offersubstantial federal tax advantages and do not count againstfinancial aid eligibility they can maximize parent's investmentresources.
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