A Guide to Saving for CollegeSubmitted by JMB Financial Managers on August 22nd, 2019
There is no "magic wand" or one-size-fits-all plan to save for college. As you can imagine, multiple factors impact the type of account you will utilize. You may even want to use a combination of options to maximize the amount you save and minimize the tax you pay on the money earned by the account(s). Here is a look at five of the most common education savings vehicles used by parents, grandparents and students to save for college:
US Savings Bonds
The US Treasury makes two types of savings bonds available to investors seeking a high degree of safety and a tax-free way to save for college – the iBond and the EE Bond.
Both types of savings bonds come in either paper or electronic form, and can be purchased from most financial institutions or via the U.S. Treasury's website. U.S. citizens, official U.S. residents, and United States government employees can buy and own savings bonds.
The more commonly known EE Bond is a very low risk investment. They are designed to retain value and never decrease, so you will never lose money with savings bonds. They pay interest they earn interest monthly, but do not pay that interest until they mature or are redeemed.
The lesser known iBond is also a very low risk investment, and work exactly like the EE Bond in every way except for one difference: they pay an additional “an inflation rate” over and above the interest earned, based on the Consumer Price Index. The rate changes twice a year and offers some protection against inflation.
If you redeem either form of savings bond to pay for college tuition expenses, you the interest earned becomes tax free income.
*The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisors LLC nor any of its representatives may give legal or tax advice.
Uniform Gift or Transfer to Minor Accounts
The Uniform Gift to Minor Account (“UGMA”) and its cousin the Uniform Transfer to Minor Account (“UTMA”) accounts are considered the granddaddy of college savings accounts.
The UGMA and UTMA are nothing more than custodial accounts, which are used to hold and protect assets for minors until they reach the age of majority in their state. A custodial account is not an education-only savings account, and your kids may use the money you contribute however they choose -- once they reach the age of majority in their state. While still a minor, parents may use the money for education expenses.
UGMA and UTMA accounts can be opened at most financial institutions, and come with a variety of investment options such as money market accounts, certificates of deposit, stocks, bonds, mutual funds and exchange traded funds, which present a wide range of risk profiles to choose from.
Because the assets are considered the property of the minor, a certain amount of the investment income will go untaxed while an equal amount is taxed at the child’s tax bracket, instead of the parents’ tax bracket.
Coverdell Education Savings Accounts
Congress created the Coverdell Education Savings Account (“CESA”) as an update and replacement for the Education IRA which was phased out in 1997. These accounts designed to encourage savings to cover future education expenses such as tuition, room and board, books, laptops, and even uniforms. You may contribute $2,000 per year to a CESA.
CESAs can be opened at most financial institutions, and come with a variety of investment options such as money market accounts, certificates of deposit, stocks, bonds, mutual funds and exchange traded funds, which present a wide range of risk profiles to choose from.
CESAs allow money to grow tax deferred as long as they remain in the account, and for proceeds to be withdrawn tax-free for qualified education expenses at a qualified institution.
529 College Savings Plans
A 529 plan may be established by anyone, including non-relatives, for a designated beneficiary who could be your child, grandchild, spouse or even yourself. The assets of a 529 belong to the plan holder, not the beneficiary (although these can be the same person). The plan holder may choose to switch beneficiaries of a 529 plan, or transfer it to a member of the beneficiary's family. Contributions should not exceed the cost of education nor any limit set by the state you open the account in.
529 plans can be opened at most financial institutions, and come with a variety of investment options such as money market accounts, certificates of deposit, stocks, bonds, mutual funds and exchange traded funds, which present a wide range of risk profiles to choose from.
A 529 plans are a tax-advantaged savings account designed to help pay for education. A 529 plan allows a person to grow their savings on a tax deferred basis on behalf of the beneficiary. Proceeds to be withdrawn tax-free for qualified education expenses at a qualified institution.
*Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan.
A brokerage account is an account you can open with an investment (i.e. mutual fund) company or brokerage firm. There is no limit to the amount you may contribute in a year.
Brokerage accounts offer you access to a range of different investments, including stocks, bonds, mutual funds, index funds and exchange-traded funds. Many brokers also offer more complex investments, like options, forex or futures, as well as safer investments like CDs, bonds and cash management accounts.
Brokerage accounts are not an education-only account, and you may use the money you contribute for any purpose. Earnings are completely taxable to the account owner.
Setting aside money to pay for a college education can be confusing for parents and students alike. In this post, we have provided five of most common types of accounts used to save for college expenses. Now that you know the basics about accumulating funds to pay for college, it is up to you and your child to utilize them. Working with a registered investment advisor™ to prepare and follow an investment roadmap from now through graduation can help prime you for success.
Contact us today, to learn how you can get started implementing these proven strategies.
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