If you are a parent or a relative who is thinking of a great way to save college money for the children in your family, Education Savings Plans may be the right choice for you. There are many things to take into consideration if you're thinking of participating in one of these. First, you have to choose which plan is right for your family based on your financial needs and goals. In addition, the age (under 18) of the beneficiary or of the student who will benefit from the plans is also critical. Because of these factors, the information presented here is mostly useful for parents or relatives of young children who are looking to save money for future college-related expenses.
The two Education-savings plans, Coverdell education savings account and 529 college savings plans, have some similarities. In both plans, the money that is contributed come from after-tax dollars. This means that the money that is contributed to these plans is subject to income tax before it gets to the account. However, the earnings and withdrawal from Education-savings plans are tax-free as long as the money is used in paying for college tuition, living, and other eligible expenses.
Because the two plans are different in many ways, here are a few things to consider:
Coverdell Education Savings Account
These are Education-savings plans that are sponsored by the federal government. There is an annual limit to the dollar amount contributed into these accounts. However, parents or relatives can set up several accounts at various financial institutions as long as their contribution does not go over the annual limit.
Coverdell savings accounts have its advantages in a sense that contributors/donors have the flexibility to choose which types of investments the money will go into. For example, you may invest in stocks, bonds, mutual funds, certificate of deposits etc. In this way, you can choose either an aggressive or conservative investment strategy which will depend on how much time you have to invest or how much risk you are willing to take.
529 College Savings Plans
These are Education-savings plans that are sponsored by the state government. Every American state currently offers 529 plans.
Like the Coverdell account, your contributions are not tax-deductible but your withdrawals and earnings are tax-free as long as you use the money for eligible educational expenses. There two types of 529 savings plans and they are savings/investment plans and prepaid tuition.
The savings/investment plan can be compared to a retirement account such as a 401K which is designed to pay for eligible college expenses. As with the Coverdell plan, parents can choose an investment strategy that fits their needs. Furthermore, parents usually don't have to be a resident in a particular state to open these Education-savings plans. In this way, parents can search for better deals and will have several colleges to choose from.
Under the prepaid tuition plan, parents can purchase college units at any state college or university at current prices as long as the donor is a resident of that state. However, tuition fees today are more likely to increase in 10 years or even a year from now. As a result, parents and/or donors may have to pay additional tuition fees in the future. Also, tuition costs are most likely higher in private colleges if your child decides to go to one. In both cases, parents would have to come up with the difference in tuition fees. Looking at the bright side, parents would not have to pay for the full cost of tuition during the time of college attendance since they originally set aside some money to pay for part of it.
Some things to consider:
As with any investment, there are risks and/or management fees associated with Education-savings plans. As long as your earnings or return on investment are greater than your losses, then having these plans is a good choice. Another thing to keep in mind is financial aid eligibility. If your family has low to moderate income, having these plans may affect your child's federal aid eligibility.
Another risk, which is not associated with investing, is the probability that your child would not want go to college. In most cases, the money can be withdrawn by paying a penalty fee or rolled-over to another student relative such as niece, nephew, etc without paying a penalty. The best thing to do when considering these plans is to do your research while also taking into account unexpected events.
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