529 Plans
This is the plan most people are familiar with and they offer some great tax advantages. You can deduct 529 plan contributions on your state income tax return, earnings on the account are deferred from federal and state taxes, and you won’t be taxed when you spend the money either, as long as it’s used for qualified education expenses, like tuition, fees, books, computers, and other supplies, as well as room and board if your student is enrolled at least half-time. In addition, recent legislation has made it possible to use a 529 to pay for up to $10,000 of K-12 tuition annually and up to $10,000 of lifetime qualified student debt.
If you’re wondering how much you can contribute to a 529 plan each year, the answer is as much as you want, as there are no annual contribution limits. However, since contributions are considered gifts for tax purposes, higher amounts may be subject to gift taxes. One way to avoid this is through something called “superfunding,” or 5-year gift-tax averaging, which lets individuals front-load up to $75,000 to a 529 plan ($150,000 for couples) and treat it as if it were spread over a five-year period. Each state also has a maximum aggregate contribution limit per beneficiary to prevent contributions beyond what would be necessary to pay for that beneficiary’s education costs.
Each 529 plan can have only one beneficiary at a time, but the beneficiary can be changed, and in the event of a beneficiary’s death, the account can be passed on to a family member. Money can be kept in a 529 indefinitely and there are no age limits for contributing to or using a 529 plan. This flexibility can allow for the creation of what’s known as a “family dynasty” 529, which can be used not just for your children or grandchildren, but for generations of family members to come.
Other College Saving Options
A Coverdell Education Savings Account is another possibility, but it has numerous restrictions that 529 do not, such as a $2,000 annual contribution limit, age limits for beneficiaries when the account is established, income limits for contributors, and the fact that all funds must be spent by the time the beneficiary is 30 years old. Coverdell accounts do have more flexible investment options and looser rules for K-12 spending, so they may be a good choice if you’re saving for private elementary and secondary school.
If your retirement needs are squared away, funds from a Roth IRA can be used to cover college expenses as well. Contributions to a Roth IRA can always be withdrawn without tax or penalty, and earnings can be withdrawn without tax after the owner reaches age 59 ½. In addition, if an account has been owned for five years and a qualified reason exists, the owner can also withdraw earnings without penalty, but the earnings will be subject to taxation if the distributions exceed the contributions. Combining a 529 plan and a Roth IRA could help you manage the taxes that can occur when spending large chunks of money on education.
Other less frequently used education savings vehicles include education savings bonds (Series EE and I issued after 1989), 2503(b) or 2503(c) trusts, and Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts.
With all the options available, as well as financial aid, scholarships and grants, things can get confusing fast. Getting advice from a financial advisor you trust can keep you on the right path.
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