If you have children and are saving with plans for them to attend college, have you done the math to figure out how much their education will cost? According to the College Board, a nonprofit focusing on higher education issues, the "moderate" college budget for an in-state public college averaged $25,290 for the 2017-18 academic year, while a moderate budget for one academic year at a private college averaged $50,900.
"If you are saving for your child's college fund, you can use one or a combination of these investment and tax-advantaged strategies," said Karen Wimbish, head of product for U.S. Bank Wealth Management. "It pays to research the different ways to start a college fund and learn which ones will work for your family."
Investing money for college tuition over many years can help ease the burden rather than trying to save a lot of money just before sending your kid off to college. Investing in a state-sponsored 529 college savings plan allows investment gains to grow tax-deferred, and withdrawals are not federally taxed if they’re used for qualified college expenses. 529 plans are among the most popular choices for families, thanks to the tax benefits on earnings and withdrawals.
With a traditional IRA, withdrawals on contributions are exempt from the 10 percent federal early distribution tax penalty when used for qualified college expenses. Keep in mind income tax will still apply. With a Roth IRA, students can make withdrawals from the contributions without tax penalty for any reason, including college costs. However, a Roth must be funded for five tax years before withdrawals can be made without penalty and a limit of only $5,500 can be deposited into the account per year.
Is your child going to follow in your footsteps and attend the same state university as you, your parents or grandparents? If this is the case, you’ll be a good candidate for prepaid tuition credits. These allow families to invest in tuition for a specific college or university, “locking in” the costs years before the student will attend that school. Plans vary from state to state, and school choices are limited. Some states also allow a deduction on their state tax returns for contributions to these plans.
Similar to a 529 plan, when money is withdrawn from this type of savings account for qualified educational expenses, it is not counted as part of the taxpayer’s income. However, an ESA has limits on how much money can be contributed annually. If you’re hoping to benefit from gifting money to the future student in the family, be aware that family members cannot claim donations to an ESA as a tax deduction.
When family members make a contribution into UTMA accounts, students are protected from tax consequences of receiving a financial gift. However, the earnings will be taxed to the student, and the total money in the accounts can affect how much the student qualifies for in financial aid.
Looking for a digital gift to give? Qualifying bonds are federally tax-deferred and tax-free at the state level, while certain post-1989 EE and I bonds may be redeemed federal tax-free for qualified higher education expenses. Students who own the bonds might be affected regarding how much money they qualify for in federal student aid if they use the bonds to help pay tuition costs.
If you have grandparents or other family members wanting to start a college fund for your children, encourage them to donate towards their higher education expenses. The good news is making a qualified monetary gift directly to an educational institution to pay for a student’s tuition does not count as a taxable gift to the student. However, if the student intends to apply for additional federal aid, this gift could affect how much money they qualify for.
There is a gifting limit of $14,000 for individuals and $28,000 for couples in low basis stock. And if the student’s interest earned from the stock, dividends and other unearned income totals more than $2,000, that excess will be taxed at the parents’ tax rate.
“As you can see, there are many avenues parents and families can take to help pay for a child’s college education,” Wimbish said. “We always recommend you ask your financial advisor about the plan specifics offered in your state so you get the best tax values.”
Learn more about funding your child’s education with smart investment strategies.