When it comes to saving money for college, there are a lot of options. A parents saving money for children’s college fund there are different ways to title those accounts, jointly or otherwise. Believe it or not, saving up money so your kid can go to college is a lot more about actually doing it, than how you do it. Most parents let a sizable amount of time pass in between college investments and that is a much bigger deal than exactly which kind of college savings account is right for you.
Assuming you don’t want to stick money into a mattress, you are going to need some kind of bank account or other financial account to store up that money you need to save and invest. Here are the options.
529 College Savings Plans
If the 529 plan came first, there wouldn’t be so many other ways to save for college. It is, quite simply, the best possible way to invest for college for most people. A 529 college account works a lot like a Roth IRA plan for college. You don’t get a federal income tax deduction for your contributions, but the money you put inside grows tax deferred, meaning you don’t have to pay any capital gains taxes or taxes on interest earned. As long as you use the money for expenses at college or university, you don’t have to pay any taxes on the withdrawals as well. This is much better than coping with the difficulty of owing a few thousand dollars in taxes from selling investments to pay for school. Many states do give you a state income tax deduction for contributing and investing in a 529 plan. The limits for 529 plan contributions are also very high.
The Coverdell IRA was a try at a tax-advantaged college savings account before the 529 plan was invented. It works in much the same way as the 529 plan. However, there are some major differences. The first is that contributions to a Coverdell IRA are limited to only $2,000 per year. Furthermore, it is only available to families with a modified adjusted growth income of $110,000 for filing individually and $220,000 for filing jointly. Transferring the money between different children is also much more difficult. However, the one advantage of a Coverdell IRA is that money from the account can be used for high school (and even elementary and middle school) education as well. In other words, this is a good way to save up for a prep school or private high school. Otherwise, the vast majority of families will be better off using a 529 plan.
Trusts UTMA UGMA and so On
Before there were 529 plans, people used trust accounts, typically a UTMA or UGMA account as a way to save for college with at least some tax advantages. Unless you are wealthy, there is no reason to go this route. Even then, a 529 plan often works better.
Regular Savings Accounts or Regular Brokerage Accounts
If you don’t want to open a specific college investing account, you can, of course, just open a regular savings account or regular brokerage account at the financial institution of your choice. There are two major drawbacks to this arrangement, and one advantage. First, someone has to pay the taxes on all interest and capital gains during the years you are saving money. This likely won’t be much at first, but if you end up building a nice chunk of money chances are that it either generates a fair amount of interest and dividends, or capital gains. Assuming you never sell any of your investments, you might get away with it for a few years. However, if you invested $10,000 and watched it grow to $30,000 over the years, you’ll owe at least 15 percent capital gains taxes on that $20,000 of growth as you withdraw the money.
You can help with the tax issues by putting the account in your child’s name, which brings us to the other big disadvantage of these accounts. While a 529 plans funds stay in control of the owner (you), that is not the case for a regular account unless it is held exclusively in your name (which means you are responsible for the taxes.) The nightmare scenario here is that your child joins a cult, turns 18 and wants to turn all the money over to them. The more likely scenario is that they buy a car, take a trip, or do something other than what was intended for the money.
Furthermore, unless you end up paying for the whole higher education experience, your child might be able to qualify for some student aid. Much student aid is calculated based on “need.” That need is calculated based upon a small percentage of the parent’s assets being used for college and a large percentage of the student’s assets being used. A big account in the name of the student will lessen the award of need based aid.
The one advantage of this kind of account is that there are no restrictions on what the money can be used for. The bad examples of that are above, but the good examples are that this type of account could be used for down payment on a house, a wedding, or to start a business.
Best Way to Save for College
Unless you have specific, well researched, reasons for using another type of account, open a 529 plan to save money for your child’s college education. Chances are very good that any disadvantages will be outweighed by the long-term advantages. But, remember, the amount you save matters more than where you save.