How to best save for your child's education
It is best to start early when it comes to saving for your child's education. The sooner, the better. There are several different types of plans available to help you save for your child's education. Those plans include:
1. State-operated 529 plans:
Anyone can open this type of plan to help save for their children's college education. Almost every state now operates at least one 529 plan. To sign up for this type of savings plan you must first select the state plan that is right for your needs. This is based on how much you can invest, how the funds will be invested, and the tax ramifications. Then, sign up using a simple form. After signing up for the plan that best fits your needs, you will begin make deposits each year, as much as you can under the plan's guidelines. State-operated 529 plans allows your invested money to grow tax free and each plan is professionally managed. This plan allows you to save as much as a quarter of a million dollars each year for your child's college education without owing any capital gains taxes on the appreciation. The money can be withdrawn to pay for college and graduate school expenses without being taxed. You may be able to take a tax deduction for the amount invested in a 529 plan, but it has to be a plan set up in your state. If you set up a 529 plan in another state, you will not be entitled to any tax deduction your state offers. Also, keep in mind that if you decide to use the money for something other than educational expenses, you will have a 10% penalty on earnings.
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2. Coverdell Education Savings Account (CESA):
This plan allows you to save up to $2,000 each year without being taxed. The money can be used not only for college, it can be used for private school tuition, educational tutoring and even a computer for high school. This plan is much more flexible than most education savings plans. The drawbacks of a CESA are the funds in the account are considered your child's assets when calculating financial aid, which may reduce the amount of financial aid your child will be eligible to receive. Also, administrative fees can be larger in proportion to the dollars saved with smaller contributions.
3. Uniform Gift to Minors Account/Uniform Transfer to Minors Act (UGMA/UTMA):
This allows you to give your child up to $11,000 without having to pay gift tax. Your child can use the money for whatever they choose. At age 18, your child will assume complete control of the funds to use any way they see fit. This type of account is offered by most states and can be set up at a brokerage firm.
4. State prepaid tuition programs:
This program lets you pre-pay your child's college tuition. You save by locking in present tuition rates for future use. This type of plan does limit your child's college choices to the schools participating in the program.
5. Roth IRAs:
Technically Roth IRAs are a retirement plan, but there is an exception that allows you to with draw money without paying a penalty to cover your child's college education expenses. This is a great way for parents that are older to save for their child's education, because if you withdraw money from the account after you reach age 59 ½ you will not owe any taxes on the earnings. However, you will owe taxes on the earnings if you withdraw money to pay for your child's education before age 59 ½, but not on your original contribution.
