Are you wondering how you should prepare to help your child with the cost of a college education? If so, there are several savings vehicles that can be used to help fund your child’s education. The most common are the Coverdell Education Savings Account and 529 College Savings Plans.
The Coverdell is a custodial account set up for a beneficiary with the purpose of covering qualified education expenses incurred beginning with kindergarten through high school, as well as college, university and vocational schools or other postsecondary educational institution expenses. As of 2023, contributions to these accounts are limited based on income and can’t exceed $2,000 per year, per beneficiary. The beneficiary of a Coverdell has to be under the age of 18 when the savings plan begins and under the age of 30 when funds are used for education. Contributions must be made in cash, and they are not deductible, however, distributions to pay for qualified education expenses are tax-free.
529 savings plans can also be used for qualified higher education expenses including college, university, vocational school, or other postsecondary educational institution expenses as well as qualified K-12 expenses. Qualified education expenses for both the Coverdell and 529 include the cost of tuition, books, fees, supplies and equipment as well as room and board. With 529 plans there are no income limits imposed on the contributor, there is a higher annual contribution limit and there is no age restriction for the beneficiary. However, as of 2023, contributions of more than $17,000 per year per beneficiary can trigger gift tax consequences. These plans also have account balance maximums which are set by each state.
An added benefit of the 529 savings plan is that some states allow an income tax deduction. For example, as of 2023 in the state of Maryland, you can receive up to a $2,500 income tax deduction and up to $4,000 in the state of Virginia. With both the Coverdell and 529 plans, contributions can be invested in securities such as stocks, bonds and mutual funds and the earnings grow tax free. In addition, withdrawals for qualified expenses are not federally taxable.
Some retirement plans such as IRAs and 401(K)s allow distributions to cover qualified education expenses. If used for education, such distributions are not subject to the 10% early withdrawal penalty. These plans may not be the best vehicle to use as a primary source to fund education expenses but can be an alternative if you find that additional funds are required that were not accumulated by the time your child begins college.
When considering options for accumulating education savings, it’s important to consider the time frame before your child enters college, the cost of the college your child may attend and any other expense you may want to cover during your child’s college career.
You should also consider if you will be contributing to higher education such as graduate school and if so, decide on your share of contribution so you can include that savings goal in your planning.
Like with any other savings goal, the sooner you start the better. If you know you would like to cover college expenses for your children, get started as soon as financially possible. Those 18 years will fly by and when it comes to saving money, time is your friend!
