5 Ways to Save for College
September is College Savings Month! Saving early and often is the best way to prepare for educational expenses. When it comes time to pay for college, having savings will provide a family with more options. Every dollar saved is a dollar that won't have to be borrowed! There are a variety of ways to save for college. Below are five common ways that families save.
1. Section 529 Plan
These are state-sponsored investment plans that help families save for college. Contributions are not tax deductible, but earnings, if any, have the opportunity to grow tax-deferred. The earnings portion of distributions used to pay for qualified higher-education expenses is not subject to federal tax. Additionally, some states offer additional tax benefits and even grant funds to help families get started. Maine's Section 529 Plan is the NextGen College Investing PlanŽ.
2. Coverdell Education Savings Accounts (ESA)
ESAs, formerly known as Education IRAs, allow contributions of up to $2,000 annually on behalf of a beneficiary who is younger than age 18, to pay qualified education expenses. Although these contributions are not tax deductible, qualified distributions are exempt from federal income tax. The earnings, if any, will grow tax-free.
3. Traditional and Roth IRAs
Early IRA withdrawals, before age 59-1/2, are allowed without the 10% early withdrawal penalty if funds are used for qualified education expenses. With a traditional IRA, the full amount of the distribution is still subject to income tax. With a Roth IRA, the portion of the distribution that comes from your contributions is tax-free. The portion that comes from earnings is still subject to income tax unless you've reached age 59-1/2 and have held the Roth IRA for at least five years, in which case the entire distribution may be tax free.
4. U.S. Savings Bonds
U.S. Savings Bonds offer a low-risk but minimal return investment for saving for college. The Education Bond Program makes the interest on certain savings bonds (Series EE and Series I) tax free when the bonds are redeemed to pay qualified higher education expenses or rolled over into a Section 529 plan. Principal and earned interest are safe and cannot be lost due to market changes, because Savings Bonds are not marketable securities.
5. Taxable Accounts (Mutual funds, Certificates of Deposit, Saving Accounts)
Taxable accounts allow families to save using whatever savings vehicle works best. Control of the money is retained and not limited to college expenses. However, taxes are paid at the regular tax rate on any capital gains or income generated by the funds.
Be sure to investigate the options to determine what works best for you. It is important to understand how the funds are invested, who controls the funds and the level of risk. Saving for college does not need to negatively impact financial aid eligibility, so be sure you understand how the different options impact financial aid eligibility. A good place to start is www.savingforcollege.com, which even has a tool that compares the options based on the criteria that matters most to you. When in doubt, ask an expert for advice. Get the information you need and start saving - you'll be glad you did!