Helping your children obtain a college education can be one of the most rewarding experiences for a parent. It will also be one of the largest expenditures.
Fortunately, families with a desire to save for college education have powerful tax efficient tools at their disposal. This article will focus on two of the more popular college savings vehicles: 529 plans and Coverdell Savings Accounts.
State-Sponsored 529 Plans:
529 plans have many benefits and are oftentimes the preferred college savings vehicle. These plans allow relatives or friends to save money toward higher education expenses for a child or any other loved one. You contribute money that you have already paid tax on and the dollars grow tax deferred (that means the IRS doesn’t take their cut of the growth each year). When the beneficiary incurs qualified education expenses you can withdrawal the funds and pay no penalty and no federal income tax on the earnings.
These plans have no income eligibility restrictions and have high lifetime contribution limits. The lenient eligibility and contribution rules make 529 plans a viable college savings option for just about anyone. You can invest through any plan, regardless of your state of residence. However, you may receive additional tax benefits if you invest through the plan sponsored by the state of your primary residence.
States work with large investment firms to manage their 529 plans. Each plan offers a different selection of investment options. Many plans offer the hands-off approach of age-based portfolios that automatically shift the allocation of funds to become more conservative as the child gets older.
Coverdell Education Savings Accounts:
The tax benefits of Coverdell Education Savings Accounts are similar to those of 529 plans. You pay no tax on the earnings of your account as long as withdrawals are used for qualified education expenses.
Coverdell accounts have several limitations that 529 plans are not subject to. They have maximum annual contribution limits and eligibility income phase-outs. Another difference between Coverdell accounts and 529 plans is that no contributions may be made to a Coverdell account for a beneficiary that is older than 18 years of age and all accumulated funds must be used by the time the beneficiary reaches age 30. Because congress was not as friendly when establishing Coverdell accounts, they oftentimes serve as a supplement to a 529 savings plan strategy.
Unlike 529 plans, Coverdell accounts provide the flexibility to invest in a variety of investment vehicles, including stocks and bonds, whereas 529 plans offer a set of professionally managed portfolios to choose from.
Helping a child achieve their aspirations in life is rewarding in many ways. You will be able to maximize the help you provide them by making wise decisions on how to save. Of course, some of the best words of advice we can give anyone is to start saving early!
Even if your college savings goals seems overwhelming now, the proper planning and savings can put those goals in reach.
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