In 2016, the average student graduated with $37,172 in student loan debt. With some preparation, savings, effort, and knowledge by parents years before their children enter college, that number can drastically decrease.
Here are four accounts that can help you easily save for your child's college education without accruing significant debt.
A 529 plan is an education savings plan that is offered in more than 30 states. It is a tax-free option for parents to saves money, and it offers a variety of investment options that differ by each state. Each state's plan has different investment options, fees and operating costs. Additionally, many states allow you to claim state tax benefits each time you contribute to your 529 plan, and your contributions do not have to be reported on your federal tax return.
Aside from the tax benefits of this plan, all funds remain with the parents. The child has no legal rights to the funds even when they turn of legal age. Unlike other college savings accounts, with a 529 plan, there are no requirements or restrictions, such as income limits, age, or a required yearly contribution, which makes this a popular choice among parents.
Roth IRAs are best known as a retirement savings account, but they can also be used to save for college. The money in this account grows tax-free and can be withdrawn without incurring penalties as long as it's for qualified education expenses. However, this type of account has limitations: You can only contribute $5,500 per year, and your household income determines how much money you can contribute each year. The higher your income, the less you can contribute.
Additionally, when your child turns 18, the account is turned over to him or her. You no longer have any control over the money you contributed years prior. Furthermore, if money is withdrawn from the account before the age of 59 1/2 for nonqualifying expenses, you may be charged a 10 percent early-withdrawal penalty.
UGMA & UTMA Accounts
The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) offer two similar, but slightly different ways adults can transfer assets to a minor. With these types of accounts, money is held and managed by a child's custodian, such as a parent or grandparent, until the child reaches age 18 (the age of maturity generally dictated by a UGMA trust) or 21 (the age of maturity for a UTMA trust), depending on the state. When your child reaches the age of maturity, the money is then turned over to him or her.
With both an UGMA and UTMA, adults can contribute any dollar amount they desire (UTMAs allow for greater flexibility with the assets contributed – e.g., real estate – whereas UGMAs limit you to deposits, stocks, bonds, mutual funds, etc.). However, the first $1,000 of unearned income is exempt from federal income taxes and the next $1,000 is taxed at the child's rate. More than $2,000 of unearned income is then taxed at the child or the parent's tax rate, whichever is higher.
Both types of accounts are irrevocable transfers, which means once you gift assets to either of these trusts, you can't take it back. Another thing to keep in mind with both types of accounts is that the assets are considered those of the student, which will affect your child's financial aid eligibility.
Coverdell Education Savings Accounts
A Coverdell Education Savings Account is similar to a 529 plan. The money in these accounts grow tax-free and can be withdrawn tax-free as long as they are used on qualified education expenses. However, with this type of account, specific purchases from kindergarten to your child's senior year in high school may also qualify.
This education savings account has contribution limits, which are affected by your income. If your annual income is more than $190,000 as a married filer and $95,000 if you're a single filer, your contribution limits diminish. These accounts have low contribution limits for each child, such as $2,000 per year, per child.
Additionally, if there are any funds left in the account by the time the child turns 30, you may be required to pay taxes on it. Additionally, a Coverdell Education Savings Account remains your asset, not your child's, so they have no control over the funds.
While there are many ways to save for your child's college education, you must first take a look at your current situation and decide what type of account will work best for you and your financial situation. However, regardless of the savings plan you choose, you are taking the necessary steps to save you and your child thousands of dollars in the future.