How to Prep for College: Financially

How to Prep for College: Financially.

Qualified State Tuition Programs (Section 529 Plans) – Section 529 Plans are authorized under Internal Revenue Code Section 529 and are sponsored by the individual states. These programs allow parents, grandparents and non-relatives to contribute money to an account of which the child is the beneficiary. There are two types of plans: a prepaid tuition plan and a savings plan. Prepaid tuition plans guarantee that the investment will at least keep pace with increases in college tuition. Restrictions may apply regarding who may contribute to the prepaid plan and which schools are eligible. Savings plans are managed investment funds that can be more flexible. Income inside these plans is not currently taxable. Funds withdrawn to pay for qualified education expenses are also free from federal income tax. Other, nonqualified withdrawals are subject to ordinary income tax and may be subject to an additional 10% penalty tax. The child may attend almost any accredited college, university, or trade school regardless of location. These plans, having no income restrictions, are available to almost anyone. Unlike UGMAs and UTMAs (discussed below), the donor retains control over the funds. Tax-free rollovers from one plan to another are allowed for the benefit of the same beneficiary once per year. Because contributions are considered completed gifts, the plans may offer estate planning advantages. Some plans offer preferential state tax treatment. Funds may be transferred, if necessary, to certain family members of the beneficiary without penalty. Taxable withdrawals may avoid the additional 10% penalty tax if they occur on account of death, disability or receipt of a scholarship.

The availability of the tax or other benefits mentioned above may be conditioned on meeting certain requirements.

Investors should consider the investment objectives, risks, charges and expenses associated with 529 plans carefully before investing. More information about 529 plans is available in the issuer’s official statement, which should be read carefully before investing.

Coverdell Education Savings Accounts – Taxpayers may deposit up to $2,000 per year into a Coverdell Education Savings Account (ESA) for a child under age 18. Parents, grandparents, other family members, friends, and children themselves may contribute to the Coverdell ESA, provided that the total contributions during the taxable year do not exceed the $2,000 limit. Amounts deposited into the account grow tax-free until distributed, and the child will not owe tax on any withdrawal from the account if the child’s qualified higher education expenses at an eligible educational institution for the year equal or exceed the amount of withdrawal. Eligible expenses also include elementary and secondary school (K-12) costs and the cost of computer equipment, internet services, and software. If the child does not need the money for post-secondary education, the account balance can be rolled over to the Coverdell ESA of certain family members who can use it for their education expenses. Amounts withdrawn from a Coverdell ESA that exceed the child’s qualified education expenses in a taxable year are generally subject to income tax and to an additional tax of 10%.

Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) – A donor may make an outright gift to a custodial account for the benefit of a minor child. The parent or custodian may retain responsibility of management of the assets in the account subject to the terms of the act. The standard rules regarding gift tax exclusions apply, including the annual $15,000 limit. The donor may choose to contribute from a number of assets, such as stocks, bonds, mutual funds or real estate. The funds may be used for any purpose, including education. One possible problem with the UGMA and UTMA is that upon reaching a certain age, specified by each state’s laws, the child has full discretionary control over the accumulated assets and may choose to use such assets for purposes other than college funding.

Cash Value Life Insurance – Parents, grandparents, or other family members may gift premiums, and the cash value build-up inside the policy is tax deferred during the accumulation period. When the time for college arrives, the needed cash may be withdrawn from the policy (generally on a tax-free basis up to the amount of the premiums paid), or the cash values can be borrowed from the policy. In most cases, loans or withdrawals will reduce the policy’s cash value and death benefit. If the policy is surrendered or lapses, taxes may be due. If the insured dies before the child goes to school, then the life insurance proceeds can be used to fund education expenses.

U.S. Savings Bonds – Interest earned by U.S. Series EE Savings Bonds is free from state income taxes. All or some of the interest may also be free from federal income taxes if the bonds are used for qualified higher education expenses. The exclusion from federal tax is subject to an income phase-out. The bonds must be registered in the parent’s name and redeemed in the same year as the eligible tuition and fees are paid.

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Learn More: Prepping for College Financially: The Total Cost.

Read more about what the total cost of college expenses will really look like for your children and how you can set them up for financial success now.