A college education has taken the place that the high school diploma once had; it is necessary to get a job in the 21st century job force. The major problem is that is that affording to pay for college is becoming more and more difficult. Recently, the cost of a college education has risen more than double the inflation rate. Fortunately, there are more options for setting aside college money in tax-efficient investment accounts than in the past. In 2001 Congress enhanced both 529 plans and Coverdell Education Savings Accounts (formerly known as Education IRAs). Other time-tested strategies, such as contributing to a minors custodial account (UGMA/UTMA accounts), continue to offer potential benefits.
529 Plans
Like many government-related tax issues the 529 plan derives from the section of federal tax code. They were first adopted in 1996 and now are generally sponsored by individual states, but in some cases may also be sponsored by qualified educational institutions. The 2 kinds of 529 plans:
· Prepaid tuition plans allow participants to pay for future tuition at present cost levels. Usually these options are only available only to residents of the sponsoring state, and typically must be used for in-state tuition.
· College savings plans allow participants to invest their contributions in managed financial instruments. College savings plans can be used for qualified undergraduate and graduate expenses at any accredited college or university. Some 529 college savings plans allow contributions to be allocated to a specific portfolio based on your child’s age, and shifts accordingly as your child reaches college-entry time.
Advantages of 529 plans include:
· Tax-free earnings
· Gift tax benefits for contributors
· Generous contribution rules
· Account control
Evaluating 529 Plans: Questions to Ask
· Can you transfer account ownership?
· Are there contribution limits?
· Do investment choices fit your needs?
· Are there any fees?
· Is your intended school considered a qualified institution by the IRS?
Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA)
· You can establish and contribute to a custodial account in a minor’s name without having to establish a trust or name a legal guardian.
· Contributing can:
o Help a future student prepare for college costs
o Reducing the value of a contributor’s taxable estate.
· Offer favorable tax treatment of investment earnings.
· The assets in the account belong to the child, not to the contributor. When the child reaches legal adulthood at age 18 or 21, depending on the state, they can use the money for anything they want.
Coverdells
· Qualified investment accounts that allow nondeductible contributions of up to $2,000 annually per beneficiary.
· Earnings in the account are not taxed
o Withdrawls used for qualified education expenses are tax free as well.
· Assets must be used before the beneficiary’s 30th birthday.
· The designated beneficiary of a Coverdell account is free to take withdrawals at any time
o However, any amount in excess of his or her qualified education expenses will be taxable as income.
o A 10% penalty may also apply.
· Coverdells allow qualified withdrawals to be used to pay for an elementary, secondary, or college education. 529s are only for college expenses.
· Coverdells impose income eligibility limits on contributors.
o Single filers with modified adjusted gross incomes of more than $110,000 and joint filers with incomes of more than $220,000 cannot contribute.
You can use more than just one of the aforementioned options—it is not a zero sum game!