How To Plan For Your Kid’s College

by mike on June 30, 2011

Saving for your kids’ college education can be very stressful.  Many worry about their ability to afford the extremely high costs of  that education.  If you have young kids, then time is on your side!  Also, don’t stress out so much about paying for Junior’s school.  There are many ways someone can pay for college and not that long ago parents rarely paid the bill.  But if you already are putting 15% of your income into retirement, are debt free except your house, and have a emergency fund of 3-6 months worth of expenses, then you are ready to save for college.  Please don’t do so before any of the above-mentioned items are taken care of.  But, if you are ready to start saving, then here are a few options you have:

1st Choice: Coverdell Education Savings Account (ESA)

-You may invest $2,000 per year, per child with after-tax dollars that grow TAX FREE!  It works very similar to a Roth IRA.

-Who is eligible for ESA’s?

  • Beneficiary must be under 18
  • Must be used for higher education or tax and 10% penalty charged
  • Must be used or rolled to family member by age 30 or earnings are taxed and 10% penalty charged
  • Singles contributing must make less than $95,000 income.  Phase out between $95,000-$110,000.  Not eligible above $110,000 income.
  • Married filing jointly contributing must make less than $190,000.  Phase out between $190,000-$220,000.  Not eligible over $220,000 income.

-Who can these accounts be beneficiaried to if not used?

  • Child or descendant of a child; brother, sister, stepbrother or stepsister; father or mother or ancestor of either; stepfather or stepmother; son or daughter of a brother or sister; brother or sister of father or mother; son-in-law; daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; the spouse of any individual listed above; first cousin.

2nd Choice: 529 Plans

-Plans offered by states that allow for investment in mutual funds that grow tax-free for college up to $12,000 per year per child.

-The best option within a 529 plan is a self-directed plan with mutual funds your can change over time yourself.

-The other two options are age-based 529 plans (do not recommend because the returns are low) and Static Investment 529 plans that allow you to freeze your investment into certain mutual funds with long track records.

-All money put into a 529 plan is removed from your estate for estate tax planning

Who is eligible for 529’s?

  • No income limit
  • You may do more than $12,000 per year per child on a one time basis (up to $60,000!)
  • Must be used for college or transferred to another beneficiary within the defined family, otherwise there will be a 10% penalty and taxes due on gain only
  • Must be used or rolled to a family member by age 30 or the earnings are taxed and 10% penalty charged.

3rd Choice: UTMA (Uniform Transfer to Minors Act)

-The account is listed in the child’s name and a custodian is named, usually a parent or grandparent

-The custodian is the manager until the child reaches 21.

-At age 21, they can do with it what they please. (It does not have to be used for college)

-There is not a huge tax savings when it comes down to it, the money is taxed at the child’s rate.

Another thing to keep in mind: you can use money out of your Roth IRA without penalty for education expenses.  If you dip into the earnings portion of that Roth, you will have to pay taxes, though.  I really don’t recommend this, though, because you don’t want to compromise your retirement just so your little angel can have a free ride through college.  It will cost them much more later when they have to take care of you during retirement!

One final note about saving for your kids’ college: you have to be very clear with your son or daughter.  Are you planning on covering all tuition and living costs or are they responsible for some of it?  If so, how much?  What path do your expect your son or daughter to take: junior college, state school, private school, graduate school?  All of these things must be discussed so that expectations are very clear.  As I said at the beginning, don’t stress out too much about all of this.  There are alternatives to getting through college, even without student loans!  Stay tuned for a series of articles that deal with the whole concept of getting through college without debt.  It will be sure to stir up some conversation!

Photo Credit: Nazareth College

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