The 5 Most Popular Methods for Funding Education
Know which options work best for you and plan early.
With the cost of higher education rising, it’s important to determine how you and your family will fund it. There are several options to consider, each with their own pros and cons.
How much time you have to save, your access to liquidity and the types of accounts and assets you already possess can push you toward one vehicle over another. Here are five of the most popular methods of funding education.
529 Savings Plan
This flexible, state-sponsored savings account covers qualified primary, secondary, and college expenses, as well as qualified U.S. apprenticeship programs and some abroad. Investments are usually in mutual fund-like portfolios, with fixed income options available. A 529 can have certain incentives exclusively for residents of the state the 529 is administered in.[1] In a typical 529 plan:
Maximum account size varies, but there are no limits on income or age to contribute.
No federal deductions are allowed for contributions.
The account owner controls withdrawals.
Earnings are tax deferred.
A 10% penalty is charged for nonqualified withdrawals.
Beneficiaries can be changed from person to person depending on need.
Thanks to the SECURE 2.0 Act, 529 funds can now be rolled over into Roth IRAs under certain circumstances.
529 Prepaid Plan
These behave similarly to a regular 529 savings plan but allow you to prepurchase a certain percentage of tuition credits for in-state postsecondary programs that are guaranteed to be the equivalent of the future cost.
UGMA/UTMA
While not carrying any special provision for educational use, the Uniform Gifts/Transfers to Minors Act (UGMA/UTMA) lets you transfer assets to your child without setting up a costly trust. You can transfer cash, bank accounts, stocks, bonds, mutual funds, real estate, limited partnerships, fine art, patents, and royalties (for UTMA). Features include:
No annual contribution limit or withdrawal penalties
Not tax-deductible
Control of withdrawal transfer to child upon reaching age of majority
Proceeds qualified for any expense for the child’s benefit
Accounts are taxable; Under age 19, amounts over $2,600 taxed at parent’s federal rate
Coverdell EESA
Once called the “education IRA,” this savings alternative is a trust or custodial account for educational expenses, which can include a wide range of securities. Features include:
Contribution limit of $2,000 per year per beneficiary
Income contribution limits up to $110,000 for single filers and $220,000 for married
Contributions not tax deductible, but account earnings tax deferred
Tax-free qualified withdrawals
Beneficiary changes when under age 30 allowed
Roth IRA
In some cases, you can withdraw tax-free funds from a Roth IRA for qualified higher education expenses. But, considering it’s your retirement fund, use this option cautiously.[2]
Talk with your advisor to see which college savings plan – or combination of plans – is right for you and your loved ones.
[1] Certain conditions may apply. Earnings in 529 plans are not subject to federal tax and in most cases state tax, as long as you use withdrawals for eligible education expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible education expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover education costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. An investor should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
[2] Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.