College can be a very stressful and draining endeavor—especially for those who have to pay for it! In our recent blog series, we’ve talked about different options to help make college more affordable including student loans, scholarships, and tax benefits.
Our final discussion for this series is about college savings. While using a regular savings account to put away for college is a good start, there are three additional types of tax-advantaged plans available that can help out even more.
With 529 plans, contributions grow tax-deferred similar to retirement accounts. The annual contributions are limited to the amount of the federal gift tax exclusion. For 2018, the annual exclusion is $15,000 per person. Withdrawals used for qualified education expenses are not taxed at the federal level and usually are not taxed at the state level. Consequently, it is likely that taxes will never be paid on the earnings within the 529 account.
There are two basic types of 529 plans:
- Prepaid tuition plans are set up by the parent or grandparent to pay ahead for the student’s tuition at the current cost. Depending on the plan, the student may be limited in what colleges she/he can attend.
- The owner of the College Savings Plan is the person who sets it up and makes the contributions. The future student is the beneficiary of the account and the beneficiary can be changed to another child or grandchild. Most states have plans providing limited tax deductions for their residents. For example, a Nebraska resident contributing to a Nebraska college savings plan can deduct up to $10,000 on their Nebraska return.
Coverdell Education Savings Accounts
Like 529 plans, contributions to Coverdell Education Savings Accounts grow tax deferred. Contributions are limited to $2,000 per child per year. When the student reaches age 18, contributions can no longer be made to the account. There are income restrictions for the person making the contributions.
Cautionary note: The values of both 529 Plans and Coverdell Education Savings Accounts are included in the FAFSA as assets of the owner. If the student is a dependent and the savings plan is owned by the parent(s), this may reduce the financial aid available to the student. If the grandparents own the savings plan, the value of the plan will not be included in the asset portion of the FAFSA. However, any distributions taken in the year reported for the FAFSA will be included as income for the student and may reduce the financial aid available.
Uniform Gifts to Minors Act Account
The Uniform Gifts to Minors Act Account is the third type of tax-advantaged savings account. Like the other two account types, the parent or grandparent sets up the investment plan account. The account is titled in the future student’s name “under the Uniform Transfers to Minors Act.” The child’s parent is the custodian of the account. Income generated in the account is taxed each year to the child. Money in the account can be used for any purpose and is not limited to “qualified education expenses.” When the child reaches the age of majority, all funds in the account must be distributed to the child. For FAFSA purposes, the value of the account is considered in the student’s assets and may reduce the financial aid.
Paying for college does not have to be frustrating or confusing. When you consider the many options available, you can find ways to reduce the costs, maximize savings, and ensure that your child or grandchild will be able to have the funds needed to get the education they deserve.
Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.