Saving for Children's Education

According to the College Board, for the academic year 2009–2010, the average cost for one year at a four-year public college was $19,388, and $39,028 at a four-year private college. Multiply the number of years your child will be in college, then factor in the high rate of college inflation, and it can be daunting to consider the projected cost when your young person turns 18.

As you work with your financial advisor to create a savings strategy to cover future education needs, 529 Savings Plans and Coverdell Education Savings Accounts offer you two excellent options for consideration.

It’s important to initiate education funding as soon as possible. Tax benefits are realized immediately, and the longer earnings can accumulate, the better.

529 Plans
Named for the section of the Internal Revenue Code that governs them, 529 plans were first authorized by Congress in 1996. They have revolutionized the way parents save for college, much like 401(k) plans revolutionized the world of retirement savings.

Here are some key points to keep in mind:

  • There are two versions of 529 plans: a pre-paid tuition plan and a tax-free savings plan. Because of its flexibility and tax advantages, the 529 savings plan is typically the better choice.
  • 529 savings plans provide a tax-advantaged way to save for qualified higher education expenses. These plans are generally sponsored by individual states, with plan assets professionally managed by independent investment firms or state government agencies.
  • Anyone can open a 529 savings account regardless of income level.
  • Contributions to 529 savings plans are subject to gift-tax rules. Currently, you can contribute up to $12,000 per year ($24,000 for married couples) per beneficiary.
  • Currently, there is a catch-up provision that allows you to invest up to $65,000 per beneficiary ($130,000 for married couples) at one time by accelerating five years’ worth of gifts. (If you are considering this option, first review any other gifts made to that individual during that five-year period to avoid federal gift-tax consequence.)
  • You can name a relative, non-relative or even yourself as beneficiary. There is no time or age limit for use of the money, and you can change the beneficiary at any time.
    (Note: Change of beneficiary is limited to family members of the original beneficiary.)
  • Unlike some other forms of education savings, you retain control of the money with the flexibility to determine who will receive it, when, and what they can use it for.
  • To qualify for tax-free withdrawals, the money must be used for qualified expenses at an accredited college, university or specialized school. If used for any other purpose, you will be subject to ordinary federal income tax plus a 10% penalty on the earnings.
  • You can specify how the beneficiary is to use the money, such as tuition, room and board, books and a computer.
  • Each plan has a variety of investment options. Your financial advisor can help you determine the most appropriate choice within your overall financial strategy and timeframe.

Coverdell Education Savings Accounts
Another good tool to supplement your education savings is the Coverdell Education Savings Account, formerly the Education IRA. These accounts have been greatly enhanced by recent tax law changes.

  • For 2011, the maximum annual contribution is $2,000.
  • You have the flexibility to fund your Coverdell with a wide range of financial products, including mutual funds, individual securities, and bank Certificates of Deposit. 
  • If needed, you can access your assets to pay for elementary and secondary school expenses. 
  • All earnings grow federal tax-free for as long as they remain in the account. 
  • If assets are withdrawn for "qualified expenses," you do not have to pay any income taxes on those earnings. Qualified expenses refer to tuition and fees and educational-related expenses, such as the cost of uniforms, supplies and books for a child or grandchild. 
  • The maximum contribution limit is reduced for individuals who earn $95,000 or more and married couples filing jointly who earn more than $190,000. Your financial advisor can provide details.
  • Having a 529 Savings Plan does not preclude you from establishing a Coverdell Education Savings Account, provided you meet the eligibility requirements for the Coverdell.

In addition to opening a Coverdell or 529 Savings Plan, consider establishing a regular investment account for college planning, and contribute to it regularly—monthly, quarterly or annually. Contributing regularly enables you to enjoy the benefits of compounding, which is one of the fastest ways to build wealth over time. Compounding is the amount earned on your original principal plus income, capital gains and/or accumulated interest reinvested.

Ready to Take Action?
It’s important to initiate education funding as soon as possible. Tax benefits are realized immediately and, obviously, the longer earnings can accumulate, the better. If in the future, the money is needed for something other than education, you can simply pay the penalty and access it for whatever purpose you choose.

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