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Best Ways to Save for a Child's College Education

by
Bob Mason
on
11/28/2017
Best Ways to Save for a Child's College Education

We all want what's best for our children, grandchildren, and other important young people in our lives, and one of the best ways to secure that is by helping to fund their college. With costs continuing to climb, finding the most efficient and effective way to save for this specific expense grows more important each day, while the time between now and when the money will be needed grows shorter.

One of the first things you need to determine is what type of educational path the child is likely to take.

Will they be heading to college right after they graduate high school or will they take a year or more off?

Will they go to a public university or a private college; an out-of-state school or a local community college?

These are important questions, as attending a local school may eliminate room and board expenses. Other factors to be considered are whether the child will attend school full time or part-time, and whether there will be additional schooling following attaining a bachelor's degree.

Though it's nice to fantasize about athletic or academic scholarships, or even whatever grants may be available from federal, state or local sources, you can't count on any of those things: your college savings plan cannot be dependent on dream sources of income. 

What you can depend on are a couple of savings methods allowed by the federal tax code, both of which allow the money you deposit to grow tax-free.

The two plans are Sec. 520 plans (also known as the Qualified Tuition Plan) and the Coverdell Education Savings Accounts.

Though the deposits you make are not tax-advantaged and can't be written off, all interest and dividends, as well as the principal itself, can be withdrawn for qualified education expenses without any tax hit. The goal is to start saving as early as possible to allow the greatest possible amount of time to grow, and the secret to getting the greatest growth is to start with as large an amount as possible early, thus allowing compounding to work its magic. Though that may seem easier said than done, you can encourage other interested parties to contribute early to help grow the fund, as there are no limitations on who is eligible to make a deposit.

Coverdell Education Savings Account  

The Coverdell plans limit contributions to no more than $2,000 per year, and this makes it less than optimal for the large tuitions typical of college educations. It does, however, have the advantage of offering greater flexibility for the type of educational expenses it can be applied to, starting as early as kindergarten. 

Sec 529 Plan

529 plans are nearly universally accepted as the most beneficial choice for saving money for college. Though these state-run plans have limited flexibility, and cannot be used for educational expenses before college, they make up for that by permitting substantial amounts to be put away. Any interested party can make a contribution to a child's 529 account, and contributions are limited only by the federal gift tax limit ($14,000 for 2017 rising to $15,000 in 2018, as it is adjusted annually for inflation). Even that limit is made more flexible by a special exception that allows individuals to make up to 5 years of deposits ($70,000 in 2017) in advance.

This means that the accounts can quickly grow and earn money due to the possibility of significant early funding. The only limits on the value or contributions of accounts (beyond any gift tax repercussions for an individual depositor) are the total amounts set by the individual fund: these numbers vary but are generally based on how much college is expected to cost. Each plan makes this calculation individually, with some considering the costs of in-state public tuition and others figuring based upon the most expensive private college tuitions in the country. Though the current average limit is more than $200,000, there are many that almost double that amount - once an account reaches the fund's maximum, no more contributions can be made, though its holdings will continue to earn interest and dividends.

As long as the funds that are in a Sec. 529 plan are used to pay for qualified college expenses, they are not subject to taxation, and if funds are withdrawn for non-qualified expenses, only the portion that represents earnings are subject to taxation. The tax code provides an additional tax benefit on the growth part of the distributions (as long as they are spent on qualified education expenses): for those at an eligible income level, up to $2,500 can be written off as part of the American Opportunity Tax Credit.

Saving for higher education is a tremendously important undertaking, and it's essential that you do so in the most impactful way. For more information, contact a tax professional to set up an appointment for a consultation.

Bob Mason, CPA writes for TaxBuzz, a tax news and advice website. Reach his office at [email protected].

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Bob Mason

Bob Mason

Bob Mason is the founder of Coast Financial Services Inc. servicing both the Santa Cruz, and San Jose areas. Bob Mason is a skilled financial professional who is fully equipped to assist any of your accounting needs. Founding his firm in Santa Cruz, Bob understands the importance of small businesses and how they form the backbone of the area. Coast Financial Services, Inc. has been dedicated to the growth and profitability of businesses in Santa Cruz for 17 years. To learn more about Bob Mason and the rest of his team, visit their website.

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