Researching College Savings Accounts: A Demoralizing Exercise
I'm not going to lie, I was demoralized after doing the research for this post. After being infected by all of the "back to school" buzz in the air these days, I was motivated to write about saving for college. But after taking a fresh look into 529 plans, Coverdell Education Savings Accounts, and almost everything else I could think of, my conclusion seems woefully simplistic, and potentially risky. But it's risky for a reason you wouldn't immediately expect.
A brief summary of of college savings accounts is discussed below, but the full details on the options available are best found at http://investor.gov/life-events/birth/saving-your-childs-education-529-plans and http://www.irs.gov/newsroom/article/0,,id=107636,00.html.
529 Plans
This type of college savings account is offered by your state, and allows anyone - a parent, family member, or friend - to set up an account for a prospective college student. Assuming the student uses the funds on qualified educational expenses, you can save and the student can spend the funds tax-free. If you set up a particular type of 529 plan, the college student you are saving for can even be yourself or your spouse.
The downsides of 529 Plans are a little less straight forward. There are 2 types of 529 Plans with very different rules and implications: the pre-paid tuition plan, and the college savings plan. I strongly recommend you review the information provided on the SEC's page to determine which type of account may be right for you: www.sec.gov/investor/pubs/intro529.htm .
Coverdell ESAs
A Coverdell ESA is a custodial account set up solely for the purposes of paying qualified educational expenses for the beneficiary of the account. There are adjusted gross income requirements that apply to the custodian of the account, and the designated beneficiary must be under 18 when the account is established.
A few of the drawbacks of a Coverdell ESA account include: 1) total yearly contributions to a beneficiary cannot exceed $2,000; 2) contributions are not tax deductible; and, 3) the funds held in the account must be distributed by the time the beneficiary reaches age 30.
My conclusion seems so simplistic after all these specifics, and should certainly not be taken as tax planning advice applicable to your particular financial situation, but here it is in a nutshell: save for your student's college education in the highest interest bearing account you can find. You will only have to pay income tax on the interest earned on these accounts, so the impact on your tax bill is likely to be minimal, and you maintain access and control over the funds while your future-college-student grows up.
But that plan is inherently risky. If you have the willpower to maintain a savings account for 10-20 years that's solely dedicated to paying for your child's educational expenses, you're fine. But if you, or your spouse, would be tempted to deplete the funds for other purposes, you're better off establishing an account that can only be used for qualifying educational expenses. The average cost of a college education has skyrocketed in the past 30 years, so the need to save early and intentionally is more pressing than ever.
So back to my original emotion after conducting the research for this post: demoralization. While I do appreciate that these type of college savings vehicles exist for the right investors, the investment vehicles available should incentivize working class Americans to save for educational expenses, either for themselves or their children and grandchildren. If we want to encourage saving and education in America, we have to start by catering the savings tools to the needs of every day Americans.
As always, this post doesn't exist in a vacuum. If you agree, disagree, or have any questions about the content of this post, we encourage you to post a thoughtful reply!
A brief summary of of college savings accounts is discussed below, but the full details on the options available are best found at http://investor.gov/life-events/birth/saving-your-childs-education-529-plans and http://www.irs.gov/newsroom/article/0,,id=107636,00.html.
529 Plans
This type of college savings account is offered by your state, and allows anyone - a parent, family member, or friend - to set up an account for a prospective college student. Assuming the student uses the funds on qualified educational expenses, you can save and the student can spend the funds tax-free. If you set up a particular type of 529 plan, the college student you are saving for can even be yourself or your spouse.
The downsides of 529 Plans are a little less straight forward. There are 2 types of 529 Plans with very different rules and implications: the pre-paid tuition plan, and the college savings plan. I strongly recommend you review the information provided on the SEC's page to determine which type of account may be right for you: www.sec.gov/investor/pubs/intro529.htm .
Coverdell ESAs
A Coverdell ESA is a custodial account set up solely for the purposes of paying qualified educational expenses for the beneficiary of the account. There are adjusted gross income requirements that apply to the custodian of the account, and the designated beneficiary must be under 18 when the account is established.
A few of the drawbacks of a Coverdell ESA account include: 1) total yearly contributions to a beneficiary cannot exceed $2,000; 2) contributions are not tax deductible; and, 3) the funds held in the account must be distributed by the time the beneficiary reaches age 30.
My conclusion seems so simplistic after all these specifics, and should certainly not be taken as tax planning advice applicable to your particular financial situation, but here it is in a nutshell: save for your student's college education in the highest interest bearing account you can find. You will only have to pay income tax on the interest earned on these accounts, so the impact on your tax bill is likely to be minimal, and you maintain access and control over the funds while your future-college-student grows up.
But that plan is inherently risky. If you have the willpower to maintain a savings account for 10-20 years that's solely dedicated to paying for your child's educational expenses, you're fine. But if you, or your spouse, would be tempted to deplete the funds for other purposes, you're better off establishing an account that can only be used for qualifying educational expenses. The average cost of a college education has skyrocketed in the past 30 years, so the need to save early and intentionally is more pressing than ever.
So back to my original emotion after conducting the research for this post: demoralization. While I do appreciate that these type of college savings vehicles exist for the right investors, the investment vehicles available should incentivize working class Americans to save for educational expenses, either for themselves or their children and grandchildren. If we want to encourage saving and education in America, we have to start by catering the savings tools to the needs of every day Americans.
As always, this post doesn't exist in a vacuum. If you agree, disagree, or have any questions about the content of this post, we encourage you to post a thoughtful reply!
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