Last week I discussed some of the assumptions you should be thinking about when it comes to planning for the goal of paying for your children’s college education. Once you figure out the important metrics for each child on how much money you need to save monthly, the next step is to determine which of the myriad savings vehicles out there will serve you best in reaching your goal. Since the tax laws and legal laws are different from state to state, I highly recommend you consult a financial advisor and/or a CPA before you make any final decisions as each of vehicles have tax and/or control implications down the road. Here are few types of options that you may consider when investing your lump sum or monthly savings.
- 529 Plan Or Prepaid Plan – 529 Plans are usually where I get the biggest questions when it pertains to college planning. Essentially, 529 plans are a way to save after-tax dollars into a vehicle that will grow tax-deferred, and can be pulled out tax-free down the road for your child’s college education. The best resource on the internet is a website called www.savingforcollege.com founded by a gentleman named Joe Hurley who I have had the privilege of interviewing several times on the radio. It is important to compare these plans state to state as investment choices vary as well as the potential tax breaks available to someone who lives in state. Most brokers/financial advisors won’t sell you the in state plan as some of those plans don’t generate commission so they will sell you out of state plans. This is something to watch for in the process. Also, since the beneficiary can be changed from one child to another, I am a bigger proponent of putting more in your first child’s name as the unused residue can be transferred to the next child. Last, many of these plans have a finite number of investment choices so you will have to watch performance closely to hit your goals.
- Uniform Gifts To Minor Act/Uniform Transfer To Minor Act (UGMA/UTMA) – In this type of college education savings account, you as the parent are actually making a ‘gift’ into your child’s name. This means when they hit your state’s majority age, the money in the UGMA/UTMA will technically become their money at that time. This feature can make a UGMA/UTMA account make parent’s feel shaky. However, these accounts offer a lot more flexibility of investment choices than your 529 plans as you can set these up at most major brokerage houses, insurance companies, and banks. In addition, you get a small tax break through these accounts with something called the kiddie tax. This means that the first $950 of interest/dividends earned on the account is tax free and the next $950 of interest/dividends earned on the account is taxed at the child’s rate.
- Savings Bonds– I remember as a kid getting Savings Bonds from my grandmother and thinking, “what am I going to do with these?” Most of us just ending up putting them in an envelope in our sock drawer or at a safety deposit box in the bank until we actually remembered we had them. Savings bonds can be an easy way to save for college education because many employers will allow you to deduct them right out of your paycheck. However, the rules have become far more stringent about whether you can use the Savings Bonds tax-free for college education. They can only be used for tuition, and the income limitation phase outs are fairly low in today’s income standards. One good thing about these bonds is that they work on a set interest rate. This can be beneficial if you want to take the uncertainty of the stock market out of the mix.
- Coverdell/Education IRA– One final vehicle to mention is a Coverdell IRA. Essentially, this vehicle allows you to put post-tax dollars into an IRA that will grow tax-deferred and can be pulled out tax free for any type of education. Since the 529 plan is dedicated for college only, this vehicle (as does the UGMA) gives parent’s the ability to save money for goals such as private elementary, middle, or high school. Like any IRA, you can save the money in any type of investment instrument allowed in an IRA. However, it is limited to a small dollar amount per year so it won’t get you too far if you have big savings goals.
You may have figured out from this blog that picking the right type of college savings vehicle is going to make you do your homework. There were another 4 or 5 savings methods I didn’t mention in the blog as well. You need to determine if one of these or a combination of savings vehicles is the right strategy for accumulation and distribution of your college funds. The earlier you get started on these goals, the easier they will be to hit as you have a much shorter time frame than a goal such as retirement. Your particular circumstances, number of children, overall asset base, income level, and many other factors will determine what the best strategy is for your family situation.
Ted Jenkin, CFP®, AAMS®, AWMA®, CRPC®, CMFC®, CRPS®
Co-CEO and Founder oXYGen Financial, Inc
oXYGen Financial, Inc. co-CEO Ted Jenkin is one of the foremost knowledgeable professionals in giving financial advice and Smart Money Moves to the X and Y Generation.
Phone 1.800.355.9318 or 770.777.0427
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