The staggering student loan debt in the US, which has recently surpassed $1.7 trillion, highlights the increasing importance of a college education in today’s job market. Parents strive to ease the financial burden for their children’s future by setting up college savings accounts early on. But what type of account should you choose, and how can you gain tax benefits while providing for your child’s education? We have the answers below, specifically tailored to government contractors.
Understanding College Savings Accounts
There are various types of college savings accounts available to parents seeking to plan for their child’s education. Let’s take a closer look at some popular options:
- Coverdell accounts: These accounts have an annual contribution limit of $2,000 per child. While they may not be suitable for parents aiming to save larger amounts each year, the earnings on these accounts are tax-free when used for qualified education expenses. Notably, this also includes K-12 private school tuition.
- Custodial accounts: Custodial accounts allow contributions of up to $15,000 per individual or $30,000 per couple annually without incurring gift taxes. While the earnings are taxed at the child’s rate, which is typically lower than the parents’ tax bracket, these accounts transfer to the child when they reach the age of majority (18 or 21, depending on the state). Unlike other accounts, the funds can be used for any purpose, not just education expenses.
- Traditional savings accounts: While traditional savings accounts are easy to set up and make deposits into, they offer low-interest rates and no tax benefits. Nevertheless, having a savings account can still teach children the importance of saving money. However, when it comes to education expenses, other accounts usually provide more advantages.
- 529 accounts: For most families, a 529 plan is the preferred method of saving for college. These accounts are not subject to state or federal taxes, and individuals can contribute up to $15,000 per year without incurring gift taxes. The growth on the funds is tax-free if used for qualified education expenses, which encompasses tuition, books, room and board, and other college-related costs. Additionally, 529 accounts can be used for trade schools and K-12 private school tuition (up to $10,000 per year, per child).
As 529 accounts generally offer the most benefits, the focus of this article will be on them. However, we strongly encourage you to consult our CPAs to discuss your specific circumstances and determine the most suitable savings plan for your child’s future.
Choosing the Right 529 Plan
If you have decided on a 529 plan, you still need to select the specific type—either a savings plan or a prepaid plan. Every state offers a 529 plan, each with its own advantages, so it’s crucial to research the plan offerings in your state and the benefits they provide. While most 529 plans offer tax advantages, prioritize the plan’s quality and performance over potential tax breaks.
If you’re unsure about your state’s 529 plan options and associated benefits, reach out to us. We can assist you in researching and selecting the best plan for your needs.
Setting Up the Account and Naming the Beneficiary
For most individuals opening a 529 account, the beneficiary will be their child. However, it’s important to note that the beneficiary can technically be anyone with a Social Security Number (SSN) or Tax Identification Number (TIN). Since many plans offer age-based options that reallocate funds based on the beneficiary’s age, it’s advisable to open separate 529 accounts for each child you wish to save for.
To open the account, you’ll need to provide the SSN or TIN, date of birth, and address for both yourself and the beneficiary. This can often be done online, and there may be a minimum deposit requirement. Additionally, you can select the investment mix for the funds in the account.
Similar to a retirement account, it’s crucial to ensure that the investment mix aligns with your specific needs and the timeline for your child’s future education. To optimize your 529 plan and mitigate unnecessary risks, consult Peter Witts CPA. We can assist you in setting up your 529 account and establishing an investment portfolio that aligns with your needs and your child’s future.