Part 2: Beginning to Think About College for Children

Monday, November 16 at 10:20 AM
Category: Personal Finance

This is part two in a two-part series on the rising costs of college and ways to make saving for college easier. In case you missed it, check out part one.

For decades, parents have used custodial accounts to transfer funds to their minor children to help build assets for college costs. However, the 2001 tax law has enhanced the tax benefits of other types of asset ownership that should be considered. Coverdell Education Savings Accounts (Education IRAs) and Qualified Tuition Programs (Section 529 Plans) have become very attractive.

Custodial Accounts
Using a Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minor Act (UTMA) account is an easy and legal way to transfer the ownership of assets to a child. With a UGMA or UTMA account, the parent creates a custodial account on behalf of the minor child. Assets are transferred into the account and the custodian, usually a parent, manages the account until the child reaches legal age. At that point, the child can do whatever he or she wishes with the assets. Transfers to these accounts are irrevocable.

Coverdell Education Savings Accounts (Education IRAs)
Coverdell Education Savings Accounts provide parents and others the opportunity to save for a child’s education expenses in a tax advantaged account. The annual contribution limit is $2,000 for these accounts. There are also income limits for those making the contributions. 

Earnings within the account are tax deferred and withdrawals are not subject to tax if they are used for qualified education expenses. The new law expanded this definition to include expenses for elementary and high school expenses. Withdrawals not used for qualified education expenses are subject to regular income tax and a 10 percent penalty. Withdrawals must also be completed before the child reaches age 30.

Education IRA accounts function like IRA accounts and are available from most banks, credit unions, brokerage firms and mutual fund companies. Investment options vary depending on the firm. Usually there is considerable flexibility with self-directed type accounts.

Qualified Tuition (Section 529) Plans
These college savings plans are now offered by over 40 states and were also enhanced by the 2001 tax law. While the plans are offered by the state, there is no restriction on where the child attends college utilizing the funds. One potential drawback is there are usually limited investment options. It makes sense to look at several states’ programs to find one that offers the investment choices you desire.

With a Section 529 Plan, there are no income limits on the donors and contributions of up to $14,000 can be made in 2015. In addition, there are special provisions to allow a “front-end loading” of up to five years of contributions to be made without gift taxes. Withdrawals used for qualified educational purposes are excluded from federal income taxation. 

The Value of Starting Early
It can be very easy to put off starting to save for college, especially if your children are young. Yet, by starting early, even if it is just a small amount, you can make a large dent in what you will need. You can always increase the amount as you earn more, but time can be your ally.

Some Conclusions
Enabling your children to attend the college of their choice and get an education that will prepare them for a successful and productive life is one of the greatest gifts you can give. However, the costs of providing that college education can be very large. Starting earlier rather than later can make the process easier, especially with some of the tax benefits of Coverdell Education Savings Accounts and Section 529 Plans. Developing a college saving habit can provide your children with the funds they need and provide you with the satisfaction of knowing that you are doing the right thing.

Tags: College, Financial Education
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