September 18, 2020
By The Trust Company of Tennessee
As education costs increase, understanding what investment vehicles are available and what to consider when saving for college is something you should prioritize. Bank savings is important for many reasons but putting back a little extra each month may not provide enough growth for a college education. Fortunately, there are multiple ways to save for college and even K-12 expenses.
Consider the following when choosing investments:
- Taxes – determine if there are any tax consequences now or at the time of distribution.
- Contribution limits – there may be yearly contribution limits associated with some investments.
- Financial aid eligibility – understanding the Expected Family Contribution (EFC) formula is key. You can learn more about it and find worksheets at studentaid.gov. Child-owned assets or income are considered at a much higher rate than parent-owned assets and income.
- Income phaseouts – some savings vehicles are only available within certain income limits.
Popular investment vehicles for college expenses:
529 plan
These are the most popular tools for education planning, providing tax-free growth if used for qualified education expenses, including K-12 tuition. With no contribution limits and no income phaseouts, saving to a 529 account is available to everyone. Additionally, 529 plans are usually owned by a parent, which means they have a low impact on the EFC formula.
Coverdell ESA
Coverdell accounts provide tax-free growth for qualified expenses and have a more liberal definition for qualified education expenses than 529 plans. However, these plans have a $2,000 annual contribution limit that must be made before the recipient turns 18 years old, and there are income phaseouts for contributors.
UTMA/UGMA (Uniform Transfer to Minors Act/Uniform Gifts to Minors Act)
While a UTMA or UGMA is not generally thought of as an education savings tool, they still can be used for college or private school tuition. These are investment accounts, so the recipients gain full control at the age of majority, generally 21 in Tennessee for a UTMA or up to age 25 if the transferor chooses. Depending on the size of the account, this could have a significant impact on your child’s EFC as it is considered your child’s asset and income received is your child’s. That also means there could be tax implications now for this investment, as it is subject to kiddie tax.
Roth IRA
Roth IRAs are becoming a popular way to save for college because they provide parents with flexibility. They’re generally attractive to parents that do not want to invest in a traditional education vehicle in case their child takes a different path. Typically, distributions taken before age 59½ would be subject to tax penalties, but an exception exists for qualified education expenses. Since this is a retirement asset and generally owned by a parent, Roth IRA savings have a very low impact on your child’s EFC.
To learn more about education savings options for your family, contact one of our relationship managers.