With the filing deadline for the FAFSA form approaching at the end of June, this is a good time to review your college savings strategy for children not only in college, but for younger children as well.
While receiving need-based financial aid can be very beneficial, not everyone will qualify. Here are some things to consider in saving and planning the cost of your children’s college education.
Types of college savings plans
529 plans
Virtually all states sponsor a 529, they are generally offered through a mutual fund company or other type of investment firm. These plans come in two varieties. Some plans offer a prepaid tuition option, generally for public universities in that state. There is also a college savings option where money is invested in mutual fund-like options.
Some states offer a tax break on state income taxes for contributions. The money in the account can be used for normal college expenses such as tuition, books, fees and housing. You will want to consult the plan documents for more details.
Money in a 529 account can impact the student’s eligibility for some types of need-based financial aid. Money not used for a specific child can generally be carried over for their siblings or even their parents. In some cases, 529 funds can be used for high school or grade school tuition. Also note if the money is withdrawn for non-eligible expenses there may be tax consequences.
Kristin Rathjen, PFS with Wedbush Securities in Scottsdale, AZ has another take on 529 plans, “When our baby is born, most of us have grand ideas about saving for college, among other things. Unfortunately, all too often, things don’t go as planned and those 529 monies are much smaller than anticipated – or even non-existent. But don’t discount the idea of still using a 529.”
She adds, “If you’re paying for college, you may be able to contribute that money to the 529 first to get the available tax credits and then immediately remove that money for school expenses. Not the preferred method of saving and investing, but still may allow you to take advantage of tax credits. Don’t forget you can’t “double dip.” i.e. Using the Lifetime Learning Credit and the 529 to pay for the same school expenses, etc. ”
Custodial accounts
Custodial accounts fall under one of two types, either the Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). In both cases these accounts involve putting assets into an account overseen by a custodian. The account must be for the sole benefit of the minor child, the parents or others cannot touch this money for other purposes. Custodial accounts can be used for college costs and also for other purposes by the beneficiary.
Custodial accounts can have a major impact on financial aid through the FAFSA form as these assets count to a greater extent than a 529 plan as they are considered assets of the child. Custodial accounts do offer flexibility in terms of how the money can be invested, this includes stocks, bonds. ETFs, mutual funds and other types of investment vehicles.
There are specific tax rules for these accounts. Once the child reaches age 18 any income is taxed at their tax rate. For younger children, income over the $2,300 threshold is taxed at the parent’s tax rate.
Savings accounts
A savings account is an interest-bearing account opened through a bank, savings and loan or other type of financial institution. The interest earned on the account will vary, high yield savings accounts can offer the most generous yields.
The impact of this asset on the FAFSA form and other financial aid applications will depend upon who owns the account. There are generally no tax benefits to a savings account, the interest on the account will be considered as income to whoever owns the account.
A savings account can be an easy way for parents or kids to contribute money when they can. These accounts are generally very liquid so there will be no issues in accessing the money when needed.
Roth IRAs
A Roth IRA can be a solid vehicle for college savings. Money contributed to a Roth IRA, whether by the parent or the children, can be withdrawn tax-free. There could be both a tax hit and a penalty for withdrawing the earnings from the account.
A Roth IRA does not count against either the parent or the child on the FAFSA form, but withdrawals from the account to fund college expenses will.
The earnings left in the account will continue to grow tax-free until retirement. If the parents are withdrawing funds from their Roth IRA, they need to weigh the benefits of doing this for college expenses against the downside of dipping into their own retirement savings.
Saving for college can be tough, but it is an essential part of your overall financial planning. Consult with your Wedbush Securities financial advisor to discuss the best college savings strategies for your situation.
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Disclosure
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.