As always before we jump into comparing and contrasting different alternatives for college savings plans, let’s first get on the same page about some definitions.
Alternative Savings Opportunities
There are several ways you can save for your kid’s college education:
- 529 Savings Plans
- Custodial UGMA/UTMA Accounts
- Coverdell Plans
529 Savings Plan
A 529 plan is a college savings plan that allows you to invest after-tax money in mutual funds. There are several investment options you can chose from ranging from growth to conservative funds that you have control over. When you take the money out (provided that it’s used for qualified educational expenses) the distribution is free of income taxation.
Custodial UGMA/UTMA Accounts
Custodial accounts established under the Uniform Gift to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) give account holders more options on where the money is invested.
Coverdell Education Savings Accounts
A Coverdell education savings account is a U.S. tax advantaged investment designed to encourage savings to cover future education expenses such as tuition and books.
Advantages
529 Savings Plan
529 plans are beneficial because they provide tax deferred growth. Additionally, there’s no income limit for qualification. Therefore, if you make $100 million a year, you can still use a 529 plan and reap the tax benefits.
Contributions to the 529 plan varies from plan to plan. Most plans do permit total contributions in excess of $250,000 per beneficiary.
Additionally there is some flexibility if your child does not go to college. You can:
- Change beneficiaries
- Transfer it to another child, a niece/nephew, a grandchild
- Use it for yourself to further your education.
- And of course, you can always take the money out. You just pay a 10% fee on the money earned (not what you put in). And you’re taxed on that amount as well. But it doesn’t usually end up being a substantial amount.
Custodial UGMA/UTMA Accounts
Custodial accounts give you more investment options. You also have more ways you can use the money in the future in addition to college. These accounts do not limit expenses to education and can be used for anything related to the child. When the child becomes a legal adult, they can use the money without limitations
This may be a good option to consider if you are unsure if your child will be interested in attending college. Plus there is no limit on how much money you can contribute.
Coverdell Education Savings Accounts
A significant benefit to the Coverdell alternative is that you can invest the money in different ways. For example, you can use individual stocks rather than being limited to mutual funds or ETFs.
Another advantage of the Coverdell option is how you’re authorized to use the savings. Specifically, the definition of educational expenses within this option is more liberal and covers more expenses.
Disadvantages
529 Savings Plan
One downside to 529 plans is that you’re limited to mutual funds or ETFs. Unlike the Coverdell option, you aren’t able to use stocks. But don’t get overly excited about the Coverdell option just yet. It has some glaring disadvantages.
Custodial UGMA/UTMA Accounts
These accounts do not have the tax advantages of standard 529 plans. Your contributions will not provide any tax deductions or credits and any earnings are taxable.
Coverdell Education Savings Accounts
The Coverdell alterative has an annual cap of about two thousand dollars. Therefore, it’s a relatively small amount you can invest each year. Coupled with that stipulation, there’s an income restriction. So, some individuals don’t even qualify to use Coverdell, as their annual income is greater than the amount Coverdell allows.
What’s the Best Option?
For the sake of discussion, it’s important to note some people use other alternatives for college savings. Cash value life insurance, Roth IRAs or different forms of annuities to shelter money could be used for college savings. While these alternatives may possibly work under the right set of personal circumstances, it’s imperative to work with an expert. A certified financial planner can help you understand why these options may not work as well for you. So, for most people, we’d recommend one of the other alternatives discussed above.
What’s the best strategy?
As with everything in today’s complex and ever-complicated financial landscape, the answer is “it depends”. At the end of the day, each plan may be beneficial to some people in the right situation. But the majority of folks will opt for a 529 plan over the other alternatives. Regardless of which option is right for you, it is a good idea to start saving for college when your children are young. And don’t forget to consult the alternatives with an expert who will guide you on which college savings plans are right for your personal financial situation.
Listen to more about college savings alternatives in our podcast.
