Your College Savings Toolkit
Preparing for a child's college education is a significant financial goal for many families. Fortunately, you don't have to tackle this challenge alone. There are a variety of savings vehicles designed to help you reach your goals, each with its own set of benefits. Let's explore some of the most popular options available.
529 Plans: The Go-To Choice
Named after a section of the tax code, 529 plans are state-sponsored investment accounts created specifically for education savings. They are widely considered the gold standard for college savings due to their significant tax advantages.
Tax-Deferred Growth: The money in your 529 plan grows tax-free.
Tax-Free Withdrawals: You won't pay any federal or, in most cases, state taxes on withdrawals as long as the funds are used for qualified education expenses. This includes tuition, fees, room and board, books, and even computers.
Flexibility: If your child's plans change, you can easily transfer the funds to another eligible family member.
New rules from Secure Act 2.0 have made the 529 even more flexible:
The 529-to-Roth IRA Rollover: This is arguably the most significant new rule. Starting in 2024, you can roll over unused funds from a 529 plan into the beneficiary's Roth IRA. This addresses a major concern for many parents: what happens if the child doesn't use all the money in their 529 plan?
Lifetime Limit: The lifetime maximum you can roll over is $35,000 per beneficiary.
Annual Limit: The rollover is subject to the annual Roth IRA contribution limits for that year.
Account Age: The 529 plan must have been open for at least 15 years.
Contribution "Seasoning": You cannot roll over any contributions, or their associated earnings, that have been in the account for less than five years.
Earned Income Requirement: The beneficiary must have earned income at least equal to the amount of the rollover for that year.
Expanded K-12 Expenses: The law has broadened the definition of what qualifies as a K-12 expense. In addition to tuition, 529 funds can now be used for a wider range of K-12 educational costs, including:
Tutoring and Learning Materials: This includes things like structured homeschool curricula and instructional materials.
Standardized Test Fees: You can use 529 funds to pay for tests like the SAT or ACT.
Educational Therapies: This is a big one for families with children who have learning differences, as it can cover the costs of services like speech or occupational therapy.
Other Notable Changes:
Credentialing and Vocational Programs: The new rules allow for 529 funds to be used for expenses related to certification, licensing, and other professional credentialing programs, even if they're not offered by a traditional college or university.
Student Loan Repayment: The lifetime limit for using 529 funds to pay off qualified student loans remains at $10,000 per beneficiary.
Permanent 529-to-ABLE Rollovers: The ability to roll over 529 funds to an ABLE account (for people with disabilities) has been made permanent.
Coverdell Education Savings Accounts (ESAs)
A Coverdell ESA is another tax-advantaged account that can be used for education savings. While similar to 529s, it has some key differences.
Broader Qualified Expenses: Coverdell ESAs can be used for qualified K-12 expenses in addition to higher education, covering things like tutoring and school uniforms.
Investment Flexibility: Unlike many 529 plans which offer a limited set of portfolios, Coverdell ESAs often give you more control to choose your own investments, such as individual stocks and bonds.
Contribution Limits: There is an annual contribution limit of $2,000 per beneficiary across all Coverdell ESAs, and there are income restrictions for who can contribute.
Roth IRAs: The Dual-Purpose Account
While primarily a retirement savings vehicle, a Roth IRA can also be a savvy tool for college savings.
Tax-Free Withdrawals of Contributions: You can withdraw your original contributions from a Roth IRA at any time, for any reason, with no taxes or penalties.
Penalty-Free Withdrawals for Education: After the account has been open for five years, you can also withdraw earnings penalty-free if used for qualified education expenses, though the earnings will still be subject to income tax.
No Impact on Financial Aid: Money held in a parent's Roth IRA is generally not counted as an asset on the FAFSA, which can be beneficial for financial aid eligibility.
Taxable Brokerage Accounts
A taxable brokerage account is a general investment account that can be opened with any brokerage firm. Unlike the options above, these accounts do not have specific tax benefits for education, but they offer some key advantages.
Ultimate Flexibility: There are no contribution limits or income restrictions, and you can use the money for anything, not just education. This is great for families who may have other financial goals or who have maxed out their tax-advantaged accounts.
Unlimited Investment Options: With a brokerage account, you can invest in a huge variety of assets, from individual stocks and bonds to mutual funds and exchange-traded funds (ETFs), giving you complete control over your investment strategy.
Tax Implications: You'll pay taxes on any earnings, such as dividends and interest, each year. When you sell an investment for a profit, you'll owe capital gains tax. This is a key difference from tax-advantaged accounts, but it can be managed with smart investment choices, such as focusing on tax-efficient funds or holding investments for more than a year to get the lower long-term capital gains tax rate.
Each of these savings methods has its own advantages and drawbacks. A hybrid approach, combining a 529 plan for a majority of your savings with a Roth IRA or a taxable account for added flexibility, is a popular strategy. The best choice depends on your family's unique financial situation and goals. To create a personalized plan, set up a call with Legs Financial.
