Which Plan is Best for You?
By Harold Simansky
Educational Investment Advisor
There are a number of plans to help you save for your
children’s education, but the first investment you need
to make is saving for your own retirement. Unlike
for college, you cannot borrow for retirement,
and there is no financial aid for the over-65,
Florida-bound crowd.
Because of this, don’t even think about saving for education
if you haven’t adequately funded your retirement yet. (“Adequately funded”
generally means that your current savings plus future expected
contributions will generate enough income to maintain your desired
lifestyle when combined with any other money you will be receiving,
for example Social Security.)
Here’s a second crucial point to consider: Unless you’re prepared to
use college savings solely for education, you should not consider
any of the education-focused plans. The reason being: If you find you have
to spend the money for something else, you will have to pay taxes on it
and face a penalty. So if you can’t be sure what the money is going to be used for,
a taxable account like a mutual fund or certificate of deposit is likely
to be your smartest move. You won’t get a tax break, but at least you can
spend the money on whatever you want without worrying about penalties.
Now let’s take a closer look at your choices. If you have fully funded
your retirement and are prepared to lock in money for education, probably
your best bet is a 529 Savings Plan or a Coverdell Education Savings Account (ESA).
The Argument for a 529
While there are numerous differences between 529s and ESAs, the biggest is that a 529
Savings Plan allows you to contribute far more than an ESA. Contributions to an ESA
are limited to $2,000 per year per student, while contributions to a 529 Plan can
be as high as $12,000 per year per contributor. For those wishing to contribute
even more, 529 Plans allow a one-time contribution of up to $60,000 per contributor
per student. This means that a couple could put as much as $120,000 into a 529
account at one time. One-time contributions come with a rule: You cannot give
any more money to this student for a period of five years.
Another advantage for a 529 Savings Plan is its flexibility. It is fairly
easy to change beneficiaries – or even take the money back – if you as
the owner decide you need it for something else. Yes, you will have to
pay a 10 percent penalty if the money is not used for education, but that
is better than not having access to the money if you really need it.
The Pros and Cons of an ESA
If you are saving money for your child to attend a private primary or
secondary school, this is the plan for you. An ESA is the only savings
program in which the money can grow tax-advantaged and still be used for
private school. The money from a 529 Savings Plan can be used only for college.
Unlike with a 529 Savings Plan, there are income restrictions for contributors to an ESA.
Under current law, contributors must have less than $190,000 in modified adjusted
gross income ($95,000 for single filers) in order to qualify for a full $2,000
contribution. Of course, there is one way around this issue: Simply gift the
$2,000 to the student and have him or her make the contribution to the ESA.
Be warned, however, that the effect this arrangement will have on financial aid
eligibility is not yet clear. While ESAs are generally considered the asset of
the parent – thus having only a small effect on financial aid – such a gifting
arrangement may change this. If this arrangement translates into the ESA being
considered the asset of the student, the hit to financial aid may be much larger.
Stand by for what the government has to say on this.
Another important distinction between ESAs and 529 Savings Plans is in the
permanency of their status as tax-advantaged vehicles. Under current law,
withdrawals from ESAs that are used for education related expenses are
free of any tax as long the withdrawal is made prior to January 1, 2011.
After that time, all withdrawals from ESA’s will be subject to some tax.
This is how it used to be for 529 Savings Plans as well, but the law was
recently changed so that withdrawals from 529 Savings Plans that are used
for education are always tax free: today, tomorrow, in 2011, and beyond.
Experts have predicted that a similar tax law change will be made with
regard to ESAs, thereby ensuring that withdrawals for education will always
be tax free even beyond 2011. While this hasn’t happened yet, it should.
The Pros and Cons of UGMA/UTMA
Uniform Gifts to Minors Act Accounts (UGMA) and Uniform Transfers
to Minors Act Accounts (UTMA) – frequently called Custodial Accounts
-- are convenient ways for parents to save for their children.
Unlike education-focused investment vehicles like 529 and ESA,
money invested in an UGMA/UTMA can be used for any expense
that is related to the child. More important for many parents,
it is an easy way to save for a child’s future without giving
up control over the funds.
These accounts offer significant tax advantages, but there is
a serious downside regarding financial aid. They are considered
to belong to the student – and thus are “taxed” far more heavily
than other investment vehicles we have discussed, specifically
529 Plans. For this reason, I recommend Custodial Accounts only
for students who are unlikely to receive financial aid.
Because most people are likely to go with a 529 Plan to save for
college, Article Six
will be devoted to helping you sort through the options. There are still
more choices to make to find the savings plan that makes the
most sense for your family.
Article #4 -
What is the Right Way to Save?
About the Author
Harold Simansky is the founder of Educational Investments, LLC, (www.educationalinvestments.com)
a Registered Investment Advisory firm focused on helping families save for
education. His book, College Costs How Much?! The Workbook to Help You Save for
School, which explains the financial aid process, is available at
www.CollegeCostsHowMuch.com. You can send
him an e-mail at Harold@edinv.com.
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