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College savings plans: 529, Coverdell, and more

Saving For College: Getting Tax Breaks And Doing It Smartly

By Dan Green

The government gives tax breaks when you save for an education. The tax-advantaged savings programs, which include the 529 Savings Plan, the Coverdell Education Savings Account and the Roth IRA, help to keep college, trade school, and graduate school costs affordable.

How Much Does College Cost Today?

Children affect your life and your budget. It costs money to clothe and feed them; and, to care for them and keep them healthy.

To educate a child costs money, too.

Beginning in pre-school and kindergarten, students are required to buy books, supplies, and tools which support their education; and those costs increase through the grade school years and high school.

It’s the cost of college, though, that can be huge.

In the United States, the cost of a 4-year college education averages between $35,000 and $120,000.

The cheapest schools to attend are public schools which are considered to be “in-state” for the student; a Pennsylvania student attending Penn State University, for example.

The most expensive colleges are often private schools.

Tuition to Vassar College in New York, for example, costs more than $200,000 for a 4-year education; and costs at the University of Southern California (USC) are about the same.

As a parent, the thought of saving for your child to attend college can feel overwhelming.  It’s not just college money you’re trying to put away, after all. You’re also saving for retirement and putting money into an emergency fund .

Plus, you have a house to pay for each month, and a vacation you might want to take. Saving for college can almost seem like a luxury.

However! If you can make saving for college tuition a regular monthly thing, by the time your first child gets to college, you’ll find yourself with a good bit of money saved up for tuition .

You might need it, too.

It’s estimated that two decades from now, the cost of a 4-year public in-state college is expected to be more than $250,000.

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Get Tax Breaks When You Save For College Tuition

For the last three decades, the cost of college tuition has been on the rise.

Today, college costs are nearly three times what they were in the 1980s, and they’re expected to rise by double the time today’s newborns enter their freshman year.

Thankfully, the IRS gives tax breaks to people who plan ahead for college.

Should you or a grandparent have plans to help pay for a child’s college tuition, make sure you get the most from your money. Consider any one of the government’s approved college savings plans.

The 529 College Savings Plan

The 529 College Savings Plan is named after section 529 of the U.S. tax code, which gives the program its tax benefits and power.

Money saved into a 529 College Savings Plan grows without taxes. And, when monies are withdrawn to pay for college, federal taxes aren’t due, and the majority of states waive taxes on them, too.

529 savings plans can be used for college tuition and room and board, trade school costs, and graduate school costs. They can also be used for job training, equipment, computers, and anything else that advances your studies.

529 plans are flexible and easy to use. You can even set one up online, if you want.

For parents that make the 529 College Savings Plan a part of their family plan, monthly contributions are often made via auto-debit, with money invested based on your child’s expected high school graduation year.

There is no limit to how much money you can put into a 529 college savings plan. And, even better is that all of the money you put into a 529 plan becomes portable.

If your child does not attend college or trade school, the money in the plan can be assigned to someone else without penalty or cost.

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The Coverdell Education Savings Account (ESA)

The Coverdell Education Savings Account is another option for parents in search of tax breaks on their college savings.

In general, the Coverdell Education Savings Account (ESA) is more restrictive than the 529 College Savings Plan, but it offers a few advantages that parents with young children may want to consider.

For example, for parents using the Coverdell plan, withdrawals can be made for elementary and secondary school expenses, which is not allowed via the 529 plan.

This means that parents who contribute to a Coverdell can use the money to pay for private school and vocational school; and for required books and equipment, including computers and tools.

Note: contributions to a Coverdell ESA are limited to $2,000 per year. This becomes a planning note for parents who expect their child’s future private school tuition to cost more than $2,000 per year.

If you already know your child will attend a school that costs more than $2,000 per year, consider putting money into a Coverdell account as soon as possible. Let the money grow with its tax advantages, and use the proceeds to pay for your future tuitions.

That makes good planning sense.

Furthermore, because Coverdell Education Savings Account allow complete control over investments, parents can give direction on how their money is invested.

This is different from a 529 plan where investment decisions are made by a manager. Coverdells provide an extra level of control.

The Questions Everybody Asks About College Savings Plans

The IRS gives tax breaks to parents who save for the education of child.

The two most common education savings programs are the 529 College Savings Plan and the Coverdell Education Savings Account.

Participation and contribution to both programs can be handled online. However, it can be difficult to find helpful information written in plain language.

Here are some of the questions which resurface over and again when parents have questions about how a college savings plan works.

If I have an emergency and need the money in my 529 college savings plan, can I get to it?

Yes, you can withdraw money from a 529 College Savings Plan in the event of an emergency. This can include medical and financial reasons, as well as for anything else.

When money is withdrawn from a 529 College Savings Plan and not used for a college or trade school expense, parents should expect to pay a federal income tax on the earnings of the money withdrawn; and, a 10% penalty for early withdrawal.

The penalty for early withdrawal is waived in certain circumstances, however, including if your child has received a scholarship; decides to attend a U.S. military academy; or, dies or becomes disabled.

In these cases, only taxes on the earnings are due.

What happens to the money in my 529 college savings plan if my child doesn’t go to college?

When a child doesn’t go to college or trade school, the money saved in a 529 College Savings Plan doesn’t “go away”. As a parent, you have options.

One option for unused 529 monies is to assign the funds to a different member of the family. This is a one-step process that costs no money and incurs no tax.

Another option is to leave the money as-is and invested. This way, if your child elects to attend college or trade school, or to receive specialized training in a field, the 529 savings plan can be used to pay for tuition.

And, of course, your money in a 529 can be withdrawn.

Cash withdrawn from a 529 plan is subject to income tax and a ten percent penalty.

What happens to the money in my 529 college savings plan if my child chooses Trade School over attending a 4-year college?

Trade school is a qualified use of the 529 savings plan. As a parent, you can use your 529 savings plan to pay for your child’s trade school.

What happens to the money in my 529 college savings plan if my child gets a scholarship?

When your child earns a college scholarship, the money in your 529 College Savings Plan becomes exempted from the program’s Early Withdrawal rule.

Parents of a child with scholarship do not pay the typical 10% penalty for early withdrawal from a 529. Taxes are due on investment gains only.

Does using a 529 college savings plan affect my child’s ability to get financial aid?

Using a 529 plan to save for college tuition may affect your child’s ability to get financial aid. However, financial aid rules tend to treat 529 savings plans more favorable than assets of other types.

In general, money from a parent’s 529 College Savings Account does not count against a student’s income calculations when that money is used to pay for tuition, which is good.

A small percentage of the money remaining, though, is used against the student’s overall financial aid package size.

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What happens to the money in my 529 college savings plan if I don’t use all of it?

Sometimes, a parent will put more money into a 529 College Savings Plan than is needed; or, the money in a 529 account will grow to be larger than a child’s individual tuition needs.

Money “left over” in a 529 savings plan can be transferred to another child without cost or penalty; or, it may be withdrawn at the cost of ten percent plus taxes on the gains.

Parents may also opt to leave any excess 529 monies in place to use for graduate school tuition or specialized training for a job.

Can I use a 529 college savings plan to pay for graduate school for my child?

The 529 College Savings Plan can be used to pay tuition, room, and board for any school type beyond high school, including graduate school.

Parents can use 529 savings plans to pay for law school, business school, veterinary school, and more.

Do I need separate 529 college savings plans for each of my children?

It’s a good idea to have one 529 savings plan set up for each of your children, but you certainly don’t have to.

The biggest reason to set up a separate 529 College Savings plan for each of your children is because the 529 program limits you to one active beneficiary per account.

This is fine is your children are 10 years apart or more, but for families with multiple children in college at the same time, it would prohibit the additional children from receiving their money.

With separate accounts for each child, parents can use multiple 529s at once in order to pay tuition for multiple children.

Can I use a 529 college savings plan to pay the tuition for a private grade school?

The 529 College Savings Plan cannot be used to pay for private grade school tuition. For parents seeking a tax break on private school education, consider the Coverdell Education Savings Account instead.

Can I use a 529 college savings plan for myself, to pay for college more cheaply?

529 College Savings Plans can be used on yourself. They don’t have to be used for a child.

Adults — with or without children — can fund a 529 savings plan then use those dollars to pay for classes at a college or trade school; or, for working toward an advanced degree.

Then, any monies left unused or untouched can be transferred to a child, grandchild, or relative at no cost and without penalty.

Written by Dan Green

Dan Green is a mortgage lending expert and the founder of Growella. Prior to Growella, Dan was a six-time, top-producing loan officer; and, ranked repeatedly among the top 1% of loan officers nationwide. Dan's home buying expertise has been in print and on TV with The Wall Street Journal, NPR, Forbes, CNBC, and others.

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