November 21, 2014 ~ Nicole Odeh
With the rising costs of a college education, the need to set money aside for education weighs heavily on parents, especially in a time when retirement is uncertain and the cost of everything appears to be constantly rising. At this time of the year, planning for the new year with comes with the looming thought of graduating children who may be headed off to college for the first time next fall. As the year closes, I get a lot of questions about smart saving for college and what parents can do now.
Fortunately, there are two savings plans available that help parents save money and provide certain tax benefits.
The two most popular college savings programs are the Qualified Tuition Programs (QTPs) and Coverdell Education Savings Accounts (ESAs). Whichever one you choose, try to start when your child is young. The sooner you begin saving, the less money you will have to put away each year, however you need to do what you can and what is best for your family.
Investing just $100 a month for 18 years will yield $48,000, assuming an 8% average annual return – this means that your $21,600 investment will more than double.
The cost of college varies greatly and depends on whether your child attends a private or state school. For the 2013-2014 school year the total expenses–tuition, fees, board, personal expenses, and books and supplies–for the average private college were about $40,917 per year and about $18,391 per year for the average public college. However, these amounts are averages: the tuition, fees, and board for some private colleges can cost more than $55,000 per year, whereas the costs for a state school can be kept under $10,000 per year.
According to the College Board, the annual increase in inflation-adjusted average tuition and fees at public four-year colleges and universities has declined in each of the past five years, from 9.5 percent in 2009-10 to 0.9 percent in 2013-14. Despite the decline, college is still expensive and proper planning can lessen the financial squeeze considerably, especially if you start when your child is young.
In a nutshell, it is expensive today and will most likely be more expensive when your child gets there.
Qualified Tuition Programs, also known as 529 plans, are often the best choice for many families. Nearly every state now has a program and there are two basic plan types, with many variations among them:
Of the two, the ESA is more highly recommended for its flexibility and growth potential. Under federal tax law the benefit can be used for qualified tuition, room, board, and books.
You may open a 529 plan in any state, but when buying prepaid tuition credits (less popular than savings accounts), you will want to know what institutions the credits will be applied to.
529 plans have no income limits on who may be an account owner. There is only one designated beneficiary per account which means that a parent with three college-bound children might set up three accounts.
So how are you saving money? Contributions made by an account owner or other contributor are not tax deductible for federal income tax purposes, but earnings on contributions do grow tax-free while in the program and the distributions from the fund are then tax-free (to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion which represents earnings).
A distribution may even be tax-free when the student is claiming an American Opportunity Credit (formerly the Hope Credit) or Lifetime Learning Credit.
The account owner may change beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.
There are many options to fund the account, including through gifts and estates, which may benefit both the contributor and recipient, but those laws are a little complex, so we will not review in this article.
Please note that state tax rules vary greatly. Some reflect the federal rules, some reflect quite different rules. For specifics of each state’s program, see College Savings Plans Network (http://www.collegesavings.org).
Not to be confused with 529 ESA plans previously discussed, the other savings option we are discussing here is the Coverdell Education Savings Account (ESAs). Honestly, the Coverdell ESA has a lot more rules than the 529 plans, but there are some unique benefits that make this plan the plan of choice for some families.
There are more rules that go along with the Coverdell ESA – we ALWAYS recommend consulting with your tax specialist on all the rules, qualifiers and fine print.
Even with all of the rules, you can see that there are great benefits. Most families anticipate having college expenses and these plans will help you save a little bit at a time, grow your savings tax free, and help your children achieve their goals.