If you’re a parent who is trying to save money for your child’s college education, then you’ve probably heard about college savings accounts. A college savings account is an account that you can deposit money into to be drawn on later when it’s time to pay for tuition, textbooks, housing, or any of the other eligible expenses that come with higher education.
However, even a brief look at college savings accounts will tell you that there are many different types out there, each with their own unique twist. Let’s take a look at the types of college savings accounts available so that you can make the best decision for you and your family.
Coverdell Education Savings Account
Coverdell Education Savings Accounts (or ESAs) are a type of college savings account that is recognized by the federal government and the IRS. This means that withdrawals from your ESA are tax-exempt as long as they’re used for expenses related to the beneficiary’s education. However, like other tax-exempt savings accounts, this means that ESAs are governed by rules and restrictions about how you use the account. Important restrictions to remember for ESAs include:
Payouts from the account are limited to qualified education expenses for a designated beneficiary. This designated beneficiary must be identified when the account is opened and must be younger than 18 years of age. However, it is possible to change the beneficiary of the account to another member of your family.
There are also limits on how much you can contribute to your ESA each year. Specifically, the maximum contribution per year, per beneficiary, over all of that beneficiary’s ESAs, is capped at $2,000. If your income is above a certain amount (which is determined at the beginning of each tax year), then you may not be able to contribute at all.
When it comes time to pay for college, distributions from the ESA will not be taxed so long as they are equal to or less than the beneficiary’s qualified education expenses. Qualified expenses include the cost of tuition, fees, and other expenses that are necessary for the beneficiary’s enrollment at their institution of choice. These expenses do not include rent, the cost of transportation, or living expenses.
529 College Savings Plan
Along with Coverdell ESAs, 529 College Savings Plans (or 529 Plans) are another popular type of college savings account. Just like ESAs, 529 Plans are tax-exempt, meaning that withdrawals are tax-free as long as they’re used for qualified education expenses.
However, unlike ESAs, 529 Plans have federal no maximum contribution limit or income restrictions on who can contribute to the account. In some states, there are contribution limits for 529 Plans, but they are much higher than the restriction on ESAs. There is also no age limit for beneficiaries. Overall, 529 Plans are extremely flexible when it comes to who can contribute and who can benefit from them.
Private Investment Account for College Savings
Both ESA and 529 Plans are tax-exempt, meaning that some withdrawals are completely tax-free. However, this special privilege comes at a price, and tax-exempt college savings accounts often have limits on how much you can contribute, strict rules about tax-free distributions, and restrictions about how the money in them can be invested or when it can be withdrawn.
Freedom from these restrictions can sometimes be a very good thing. Especially when the cost of college is affected by things outside of the usually qualified education expenses. Things like the cost of housing, living expenses, and health insurance are not usually covered by tax-exempt college savings accounts. A private investment account that’s managed by your or a financial expert acting on your behalf can give you more freedom when it comes to contributing funds, managing them, and eventually distributing them to help pay for college.
Personal Savings Account
Similar to a private investment account, personal savings account that you establish with a bank or credit union can be used to pay for your child’s college education. Withdrawals from this account will not be tax-free, even if they are used for qualified education expenses, but you will have more freedom when it comes to depositing funds and withdrawing them.
Using Your Roth IRA For College
If you’re a working adult, then you’ve probably already heard of Roth IRAs. In 2017, almost 25 million U.S. households had a Roth IRA account for their retirement savings. However, Roth IRAs aren’t just for retirement. What you might not know is that the funds in your Roth IRA can also be used to pay for college.
Even if you are still too young to withdrawn funds from your Roth IRA tax-free, you can still make tax-exempt distributions towards your child’s college education. Withdrawals that are used for qualified education expenses — defined as “tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution” — will not be subjected to the usual tax penalty that is associated with making withdrawals before you reach the designated age of retirement.
Supporting Your Child Without a College Savings Account
College savings accounts are a valuable tool that you help you pay for your child’s college education, but they aren’t for everyone. In order to be successful, college savings accounts require regular contributions that begin many years before your child first starts attending college.
Even without a college savings account of your own, it’s still possible to help your child with their college expenses. Student loans for parents can help you put together the funds to help your child with college tuition and other expenses. If you’re not prepared to take out a student loan for yourself, cosigning student loans for your child can help them get ahead.