With so many options out there, it can be tough to decide which type of savings account to use for your child’s college education fund. Here’s a quick glossary to help you understand your options.
Basic Savings Account: Money maintained in a basic savings account — the most common type of bank account — may earn a small amount of monthly interest. A small minimum balance may be required, plus you’re allowed to make a limited number of withdrawals each month. Opening an account can be as simple as visiting a local bank, showing identification, and making your initial deposit.
529 Account: This is the most common college savings plan. It allows investments to grow tax-free, and capital gains are taxed at the student’s tax rate — typically lower than their parents’ rate — when the money is used for college expenses. 529 accounts have no restrictions on the amount of income a contributor makes or the age of the beneficiary. Contributions can be made as frequently as you like. Plus, relatives and friends can make contributions. In some states, accounts are available in two forms: a pre-paid tuition plan and a savings plan. Most 529s allow you to save more than $200,000 per beneficiary.
Coverdell Education Savings Account: In a Coverdell, formerly called an Education IRA, you can contribute up to $2,000 per year per beneficiary, and funds are not taxed if used for certain qualified education expenses such as tuition, books, supplies, and possibly room and board. Contributions must be made before the beneficiary reaches age 18, and all funds must be distributed within 30 days of the beneficiary’s 30th birthday.
Roth and Traditional Individual Retirement Accounts (IRAs): You can get a distribution from your IRA, and while you may have to pay income tax on a portion of the distribution, you will not be subject to the 10 percent early withdrawal penalty if the funds are used to pay for certain qualified higher education expenses. These expenses can include tuition, fees, books, and possibly room and board. You generally can contribute up to $5,500 per year to an IRA.
To decide which path makes the most sense for you, contact a financial professional who can explain the pros and cons of each college savings option.
