Nine questions people ask about saving for college
You may be wondering how you can ever save enough to send your school-age children or grandchildren to college.
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If you’re like most Americans with school-age children or grandchildren, you may be wondering how you can ever save enough money to send them to college. Every year you hear that college costs are rising more than inflation and that, 18 years from now, it will cost a lot more to send your child to public or private school.
Even if you can’t save a lot, you can still take advantage of a college savings plan. With this in mind, we thought it would be helpful to take a look at some popular ways to save for college. We condensed the information into nine questions people frequently ask about college savings.
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Q: How can I estimate future college costs?
A: The American Funds college cost calculator can help you figure out how much a particular college will cost at the time your children or grandchildren will attend. It provides costs for a wide list of schools based on information from the College Board, as well as how much you may need to save each month to cover expenses. The calculator, combined with guidance from your financial professional, can help you work out a plan to pay for college.
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Q: Why start a college savings plan early?
A: The longer you wait, the more money you’ll need to save to meet your goal. Consider the following example: Two couples need to save $150,000 for college but begin investing at different times.
- Ann and Peter begin investing the year their daughter is born, making monthly investments of $311.
- Jack and Wendy start investing when their son is eight years old, making monthly investments of $815.
Waiting those eight years cost Jack and Wendy $30,624 while Ann and Peter benefited from eight years of compounded growth. In the end, Ann and Peter put in less money to reach their goal. (This example assumes an 8% return per year compounded monthly and that the child enters college at age 18. It does not represent a specific investment. Your investment experience may differ.)
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Q: What are some tax-advantaged ways to save for college?
A: Section 529 savings plans and Coverdell Education Savings Accounts are the two most popular ways to save for college. Many investors also use custodial accounts such as those authorized under a state-sponsored Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). You can use our college savings plan comparison chart to review the benefits and limitations of each.
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Q: What is a 529 savings plan?
A: Named after Section 529 of the Internal Revenue Code, 529 savings plans provide a tax-advantaged way to save for qualified higher education expenses. These plans are generally sponsored by individual states, while plan assets are professionally managed by independent investment firms or state government agencies. Anyone can open a 529 savings account regardless of income level and contribute up to $12,000 ($24,000 for married couples) a year without gift-tax consequences.
Several years ago, the Commonwealth of Virginia introduced CollegeAmerica®, a 529 savings plan managed by American Funds, which is open to residents of all states.
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Q: What are some features of Coverdell Education Savings Accounts?
A: Coverdell Education Savings Accounts have been offering tax-free withdrawals for higher education since 1998. Unlike 529 savings plans, withdrawals can be used for elementary and secondary education and even for academic tutoring and education-related computer expenses.
There are income restrictions though. If your income exceeds certain limits, you will not be eligible to contribute to a Coverdell account. Annual contributions are also limited to $2,000 a year.
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Q: Can I invest in both a 529 and Coverdell account?
A: Yes, investments in a 529 savings account will not affect your ability to invest in a Coverdell Education Savings Account for the same beneficiary. Investing in both can be an especially good idea because the two complement one another.
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Q: Are UGMA and UTMA accounts still good choices?
A: For many years, UGMAs/UTMAs were the only substantial education savings vehicles available, so many investors have built up sizable amounts in these accounts.
UGMA/UTMA accounts do not have income or contribution limits. And, at least part of your earnings may be exempt from federal income tax. Some or all will be taxed at the child’s lower rate if the child is under age 18.
Contributions to UGMA/UTMA accounts are irrevocable, meaning that once the money or other property has been given, you cannot change your mind and withdraw the gift.
You can withdraw money anytime for the benefit of the child — not just for education. The child assumes control of the account upon reaching the age of majority (18 or 21 in most states).
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Q: Do gift-tax rules apply to college savings plans?
A: Contributions to 529 savings plans, Coverdell Education Savings Accounts and UGMA/UTMA accounts are subject to gift-tax rules. Under these rules, you can contribute up to $12,000 a year ($24,000 for married couples) without gift-tax consequences.
Under a special election, you can invest up to $60,000 ($120,000 for married couples) to a 529 account at one time by accelerating five years’ worth of investments with no federal gift-tax consequences. If you make this election, additional contributions or other gifts to the same individual over that five-year period will exceed the annual gift-tax exclusion.
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Q: What if my child does not go to college?
A: With a 529 savings plan, you can leave the money in the account in case your child decides to attend college at a later time. Or you can select a new beneficiary, including yourself or anyone who is a member of the current beneficiary’s family. If you take the money out for anything other than education, you will pay ordinary federal income tax plus a 10% penalty on the earnings.
With a Coverdell account, the beneficiary must use the assets by the time he or she reaches age 30, or a new beneficiary must be named.
For UGMA/UTMA accounts, you will owe capital gains tax whenever mutual fund shares, stocks or bonds are sold.
CollegeAmerica is sponsored by Virginia College Savings Plan. But you can invest no matter where you live, and your beneficiary can go to school in any state. However, depending on your state of residence, there may be an in-state plan that provides tax and other benefits not available through CollegeAmerica. Before investing in any state’s 529 plan, you should consult your tax adviser.