Student loan debt in the US recently surpassed $1.7 trillion. As the price of a higher education continues to climb, so does the demand for college-educated workers. This makes attending college a virtual necessity in the job market, while also making it incredibly difficult to afford. Many parents hope to ease the financial burden for their child’s future by setting up a college savings account early on in their lives. But what type of account should you use? How do you set one up? And how can you gain a tax benefit from your efforts to provide for your child’s future? We have the answers below.
Types of College Savings Accounts
There are numerous types of college savings accounts that parents can use to begin planning for their child’s education. Here’s a quick breakdown of some of the most popular kinds of plans that parents use:
- Coverdell accounts – These accounts have a $2,000 annual contribution limit per child, so they might not be a good option for parents looking to put more away each year. However, the earnings on these accounts are tax free, so long as withdrawals are used for qualified education costs; this also includes private school tuition for K-12.
- Custodial accounts – While the earnings on custodial accounts aren’t tax free, they are taxed at the child’s tax rate, which is typically much lower than the parents’ tax bracket. Individuals can contribute up to $15,000 and couples can contribute up to $30,000 each year without a gift tax. These accounts transfer to your child at 18 or 21 (depending on your state). This means the funds can be used for anything, and not just education expenses.
- Traditional savings accounts – While easy to set up and make deposits into, traditional savings accounts earn very low interest rates and offer no tax breaks. It’s still a good idea to have a savings account for your child so they can learn how to save their own money. But when it comes to education expenses, there are usually more benefits for different accounts.
- 529 accounts – For most families, a 529 plan is the best way to save for college. These accounts are not subject to state or federal taxes, and individuals can give up to $15,000 per year without a gift tax. The growth on the funds is tax free, so long as they’re used for qualified education expenses. This includes tuition, books, room and board, and other key college expenses. It can also be used for trade schools and for K-12 private school tuition (up to $10,000 per year, per child).
Because 529 accounts are generally the best option for families, the remainder of this article will focus on these accounts. However, we encourage you to contact our CPAs to discuss your individual circumstances and get help determining the right savings plan for your child’s future.
Types of 529 Plans
If you’ve settled on a 529 plan (as most families will), you still have to choose the exact type of 529 plan you want—a savings plan or a prepaid plan. Every state offers a 529 plan, but each state’s plan has its own advantages, so it’s important to research the exact plan offerings in your state and the benefits they offer. There are tax advantages to most 529 plans, but you should prioritize quality and performance of the plan over any tax breaks it might offer.
If you’re uncertain what your state offers in terms of 529 plans and associated benefits, reach out to us; we can help you do the research and select the best plan.
Set the Beneficiary and Open the Account
For most people opening a 529 account, the beneficiary will be your child; however, it can technically be anyone with an SSN or TIN. Most plans offer age-based options that reallocate funds based on the beneficiary’s age, so it’s a good idea to open separate 529s for each child you want to save for.
You can then open the account by providing the SSN (or TIN), date of birth, and address for both yourself and the beneficiary. This can often be done online, and may require a minimum deposit to open the account. You can also select the mix of investments you would like for the funds in the account.
Much like with a retirement account, you want to ensure that the mix of investments you select meet your exact needs, as well as the timeline for your child’s future education—with diminishing risk as they draw closer to college. If you want to get the most out of your 529 plan while mitigating unnecessary risks, contact Peter Witts CPA. We can help you to set up your 529 and establish an investment portfolio that works for your needs and your child’s future.