The Best Ways to save for your CHILD'S future
Let me start by saying...no one said you have to save for your child's college. College may not be in your kid's future, you may not have the ability to provide for their college financially, or you may not want to! All of that is just fine, if you're wanting to put something away to assist your kid with college, but have absolutely no idea where to start (like we were just a few months ago) then this post is for you!
We decided we would like to help our kids with college if they choose to do that. My main concerns:
-We are still so young, and plan to have a lot of living left to do. There are a lot of unknowns and I'm afraid to lock money away we may need in the future. For example, even though we have a great start to our retirement, what if something happens that inhibits us from putting more money away for the next 30 years (loss of a job, a disability etc.)
-What if they chooses not to go to college, or don’t need the money later for other reasons? For example receives a full ride to school or lots of scholarship.
-We'd like to continue to save for another down payment on our next house.
-I want to have control over the account, because I'm a control freak.
We decided to do a combination of a couple of these routes, in order to best address my concerns. The primary ways I suggest considering to save for your child's college is one of these three ways:
1. Your own Roth IRA
2. A State's 529 Plan
3. Coverdell ESA (Education Savings Account)
Roth IRA
My personal favorite way to save for your child's college, is through your own Roth IRA. The biggest concern I have with people saving/paying for their child's college, is when the parents don't have their own financial future in order. By the time your child is in college, you need to feel pretty good about where you are in your current state, and retirement if you want to start paying for their education. That's why I love saving for college in a Roth IRA. Stocking up money in your own Roth IRA allows you to make sure you are not neglecting your future. As a reminder, a Roth IRA is money you're putting a side, after paying taxes on it. That means you can pull out the money tax-free later. The beauty of this is since you've already paid taxes on it, after 5 years you can pull out contributions (not earnings) tax-free, and when you are retirement age you can pull all of it out tax-free. I do not encourage ever touching your retirement account early, except in this circumstance if you are secure in what you have saved for your own retirement. If you don't have a Roth IRA, or don't know what that is, I've mentioned it before here. Even if you're not thinking about your child's college, I love Roth IRA accounts.
Pros:
1. You're not neglecting your own retirement and financial future
2. Pull contributions out without a penalty as long as it has been 5 years or more since you put that money in. (also when you pull money out, you assume you're pulling out contributions first, which is good) This also applies for pulling money out for things like a down-payment or emergency
3. You always have control over the money, even when your child is in college
4. If your child doesn't go to college, you can still use the money for other things in retirement. You don't lose it or face a penalty to use it for something else
Cons:
1. Contribution limits are $5,500 per year. If you and your spouse both have Roth IRA's you can each contribute that much towards your own.
2. No current tax breaks. You're paying taxes before you put the money in.
3. Can only pull out contributions without a penalty. If you pull out investment income you will pay a penalty and tax.
529 Plans
These are my second favorite, and we opened one of these for our kids. Each state has a 529 plan, and you can set one up in whatever state, no matter what state you live in. This one is a bit trickier, because every state is different. We live in Virginia, and they have a great 529 plan in my opinion.
Pro:
1. Contribution Limits are practically non existent in my book. (you can only contribute until the balance for the beneficiary reaches $360,000...I can guarantee you we won't be saving that much for college)
2. Contributions may be deductible on your state income tax return. (This depends on your state. Virginia does, for example, which is great since we live/work here and I pay Virginia state tax. It wouldn't help someone in Oklahoma to do this, unless they were working in Virginia and paying state tax there.
3. Your child does not get ownership when they turn 18, you retain control
4. The gains are never taxed if used for qualified education expenses.
5. If your child gets a scholarship, you can pull out the money equal to the scholarship amount without a penalty. The earnings will be subject to income tax at that point. That isn't so bad though.
Con:
1. You cannot pay for school expenses prior to college (example private school for high school)
2. There is a penalty for spending the money on non-educational expenses.
3. Also if you pull money out, unlike a Roth IRA you are considered to be pulling out both contributions and earnings. So it cannot double as a retirement or emergency fund for you without being penalized for taking money out.
4. Pay attention to the fees and that there is stable management with whomever you decide to fund your 529 through.
Coverdell Education Savings Account
Lastly, the ESA. There is nothing wrong with an ESA, there are some great things about them, but we primarily made the decision not to fund an ESA at this time because, I don't want our kids to have control over the account and I have no intention of ever paying for private school for them. These accounts are also fantastic ways to save, and if you're thinking of private school for K-12 I'd highly consider this. There is a big limitation based on income.
Pro:
1. You can use the money to pay for qualified K-12 education expenses
2. Contributions are post-tax, and the investment income generated is never taxed if you pay for qualified expenses
3. Rumor has it you have more control over the investments in an ESA compared to a 529
4. If your child gets a scholarship, you can pull out the money equal to the scholarship amount without a penalty. The earnings will be subject to income tax at that point. That isn't so bad though.
Con:
1. Each child can only receive $2,000 a year put into their ESA
2. Depending on the plan, your child owns the ESA when they reach 18 (so if your child decides to pull the money out to pay for whatever the cool gadget is in 2035, the child will pay a huge penalty and all you can do is smack them upside the head). I love our boys, and I'm sure they will grow up to be a great kids, but I know that my parents were smart not handing me a $60,000+ check when I turned 18 and saying "here, this is for college" because we all know where that would have gone (anything but college)
3. Beneficiary must use the account before turning 30
DISCLAIMER: This is a quick once-over of the plans that I found to be most interesting. This does not detail every aspect of the plan, and I am not giving this as expert advice. My advice is to the average person looking to compare these 3 ways of saving for your child's college. Please see a financial adviser for more information.
UGMA- Uniform Gift to Minors Act, not necessarily focused on education. It is a trust account with a group of assets you are gifting to your child. A major drawback is that the child gets full control at 18 or 21. The parent is no longer in control and you cannot change the beneficiary to another child after they reach the age of majority. Also, it will have negative financial aid impacts because it is considered income. Can be used on anything, not just education cost.
Edited to add: Since this post was published the IRS has updated its rules surrounding 529 accounts. As of 2018: “You can use the money in a 529 account for K–12 private-school education” This is something you should be be aware of what the time frame is in which you’re investing money in the 529 plan.
Also the law change in 2019, has now made it possible to use your 529 to pay for your student loans: “ The Setting Every Community Up for Retirement Enhancement Act, a spending bill known as the SECURE Act, established a lifetime limit of $10,000 from a 529 plan that can be used without any penalties or tax consequences to repay the beneficiary's student loans, including federal and most private loans. An additional $10,000 can be used to repay student loans held by each of the beneficiary's siblings.”
If you still don’t know where to get started, check out COLLEGEBACKER.COM it is a great website to use to fund your 529 plan, and you can also have family members make contributions as gifts as well, a gift that can grow overtime, yes please!!! It makes it really easy to save for college. They provide recommendations on investment portfolios and manage the portfolio for you & I am not getting paid to refer you to their site :)
