A college education is expensive. It costs around $33k per year for a student at a private college such as Stanford or Harvard, and that doesn’t include the cost of living. Even if your son or daughter attends the local state college, fees are still nearly $10k a year. Not surprisingly, for many families, a college education is out of reach.
Despite the cost, a college education is still worthwhile. Degree educated students earn more and enjoy better job security than their less well-educated peers. The unemployment rate in the US is falling, but degree educated job seekers still have an easier time finding work.
Many parents fully expect to foot the bill for their kids to attend college. They want their children to be successful, so naturally, a college education is part of the equation. The earlier you start to save, the better, as your cash pot has time to grow. The simplest way to save for your kids’ college fund is to put money into a regular savings account each month, but any interest you earn is taxable. Tax planning is a much smarter way to save for college, so what are your options?
Section 529 Plans
Section 529 of the US tax code is a useful way for working parents to build a nest egg that can be used to pay college fees. Section 529 plans offer a number of advantages over more traditional savings accounts.
There are different lifetime contribution limits, which vary between states, but any money you pay into a 529 College Plan is federal tax-free. Many states also offer tax breaks on 529 plan credits, which you can claim when you make contributions.
Newer 529 plans invest your savings into mutual funds. Portfolios are adjusted as the plan matures, to protect the pot while ensuring maximum growth potential.
Advantages of a 529 Plan
Unlike a regular savings account, parents are not hit with a Capital Gains bill when they withdraw the money to pay for college tuition fees. You can access the money before the plan matures, but withdrawals will incur a 10% penalty tax and additional income tax.
529 Plans are very easy to use. You can set up a 529 plan online and arrange for contributions to be made direct from your wages or bank account.
Each state has its own 529 plans. You are free to choose a 529 plan offered by a different state if it suits you better. Everyone is eligible to open a 529 College Plan, so if you are looking to make the most of the tax breaks on saving for college, the 529 plan is a smart choice.
Education Savings Accounts
ESAs, or Coverdell Education Savings Accounts, give you the option of saving up to $2,000 per student, per year. If you have maxed out your 529 Plan, this is a useful addition to your portfolio. Earnings on an ESA are tax deferred, and as long as you use the money to cover education costs, they remain tax-free.
Whereas a 529 College Plan can only be used to pay for higher education fees, money saved in an ESA can be used to cover fees for elementary and secondary education costs. You can also use the money to pay for “reasonable” room and board.
There are other methods of minimizing tax to help pay for college fees. For example, parents could invest in an off-campus property and let their child live there while they are at college. Charge your son or daughter rent and include the income and expenses on your tax return.
Tax planning is a complex business, so it’s a good idea to talk to a tax planning advisor if you want to save as much money tax-free for your child’s college education.