With college costs continuing to rise faster than the rate of inflation, financing a child’s higher education can be a challenge. Fortunately, there are sound strategies you can use to pay college expenses for your children or grandchildren while keeping an eye on your overall financial goals. In addition, you may benefit from noticeable tax advantages by contributing to college expenses.
529 College Savings Plan
529 plans are generally state-sponsored and permit after-tax contributions that grow taxfree until distributed. Once funds are withdrawn and used toward qualified education expenses1, they are free from federal and, in many cases, state income taxes. However, if funds are not used for qualified educational expenses, the earnings are subject to taxes and a 10% penalty. In this strategy, you retain control and must invest in the options available in the state-sponsored plan, which are usually mutual funds. You can usually change your allocation only twice per year. These plans are also treated more favorably than other types of savings for federal financial aid purposes.
Coverdell Education Savings Account (ESA)
Similar to a 529 plan, a Coverdell ESA takes advantage of federal tax-free earnings. They also allow for maximum investment flexibility. Account assets can be held in stocks, bonds, mutual funds, certificates of deposit and many other types of investments. The accounts are open only to those whose adjusted gross income is less than $110,000 for individuals or $220,000 for a married couple. Contributions are capped at $2,000 per year per beneficiary.
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