3 Tax-Friendly College Savings Options

With tuition costs rising each year, setting aside funds for college can be daunting. However, there are several tax options that may lessen the financial burden of college. We encourage you to review these plans with your family and your accountant to determine if one of them works for you.

Section 529 Plan

Consider putting after-tax money into a Section 529 college savings account. Contributions aren’t deductible, but earnings will grow tax-free in these plans when used to pay qualifying educational expenses.

  • Plan funds can be used for college tuition, room and board, computers and related equipment.
  • Unused fund earnings are subject to income tax.
  • There are no contribution phaseout limits. However, the account owner’s contributions plus other gifts totaling more than $15,000 in 2018 for one student may be subject to gift taxes.
  • Section 529 plans can also be used for up to $10,000 in tuition expenses for elementary and secondary public, private and religious school.

This option is best for parents and grandparents who want to save for their kids’ school tuition and other related expenses while still receiving a tax break.

Coverdell Education Savings Account (ESA)

The Coverdell Education Savings Account is a flexible account in which you can choose from a wide variety of investments to meet your individual needs.

  • Funds in this account can be withdrawn tax-free if used for qualified education expenses such as tuition, room and board, books, tutoring and more.
  • If the funds are not spent by the time the beneficiary is 30, the unspent money must be withdrawn (subject to income tax and a 10% penalty) or rolled over into another family member’s education savings account.
  • The maximum annual contribution per beneficiary is $2,000.
  • Unlike 529 plans, Coverdell ESA contributions begin phasing out for parents with an adjusted gross income (AGI) of $190,000 (single filers with an AGI of $95,000).
  • A Coverdell ESA can also be used for elementary and secondary school expenses.

This option is best for students who have education expense costs and want additional investment options for education savings.

Custodial Account

If you’re looking for a savings option that goes beyond education, a custodial account may work well for you. With Uniform Transfers to Minors Act (UTMA) and Uniform Gift to Minors (UGMA) custodial accounts, you can generally invest in a wider variety of options versus a Section 529 plan.

  • The funds are considered property of your child.
  • The tax advantage in these accounts comes into play for unearned income up to $2,100 per year, which are taxed at the child’s (usually lower) tax rate.
  • The annual investment earnings over $2,100 will be taxed at trust and estate rates.  This is new for the 2018 tax year.
  • There are usually no annual contribution limits, but contributions of more than $15,000 may be subject to gift tax rules.
  • The biggest potential disadvantage is that you gift the funds irrevocably to the child. At a certain age, your child controls the account and could spend the funds on something besides college.

This option is best for parents who give financial gifts to their kids and don’t mind handing over control of the accounts when they are 18 or older.

If you’d like to discuss these college saving options, please contact Cray Kaiser at 630-953-4900.