It seems like every year the cost of college tuition is getting more and more expensive and the sooner you start saving for your child’s future, the better off they’ll be in the long term. One of the most popular options for saving for your child’s college future are the 529 plans and Education Savings Accounts. Unfortunately, many parents are not well-versed in the specifics of these plans and how to find one that works for your budget and family needs.
Introduced in 1996, 529 plans offer federal tax exempt savings plans and are named after Section 529 of the federal tax code. Every state has its own 529 plan but the money can be transferred to another state if the child chooses to go to college elsewhere. In-state residents receive tax exemptions on their 529 plans depending on whether the state is subjected to a state income tax.
As long as you are a US citizen over the age of 18, you’ll be able to open a 529 plan for you, your children, grandchildren, or a younger relative. As long as the funds are used on educational expenses only, the money will never be taxed whenever the time comes to make a college tuition payment. There are two different kinds of 529 plans: prepaid and savings plans.
The prepaid option allows you to lock in the current tuition rate, which will inevitably rise in the years to come. Prepaid 529 options do have downsides, as the funds cannot be used for expenses like room and board or books.
The savings plan option works similarly to any IRA or 401k account. You would invest your money into mutual funds or another investment option and based on how the investment performs overtime will determine how much money you can make. This plan has the potential to earn you a lot of money, but, just like investing in the stock market, you are taking a bigger risk than with the prepaid plan.
Coverdell Education Savings Account
Also known as just Education Savings Account or ESA, these plans are quite similar to 529 Plans in that they are tax exempt on the federal level and can be used for any future education expense. The glaring difference between an ESA and a 529 Plan is that the ESA can be used for any primary or secondary education expense, rather than just for college or university expenses.
Some parents choose to invest in their children’s future by using a Roth IRA but this is not the best option because withdrawals from the account are not tax exempt if the person withdrawing the funds is under the age of 59 ½. Others choose to put money into a CD or bank account, however this option does not typically yield a high annual interest rate. The options that are going to give you the best results are the 529 Plans and Coverdell Education Savings Account (ESA).