The Truth About Saving for Your Kid’s College (And How to Do It Right)
EXPLORING EDUCATION SAVINGS PLANS SO YOU CAN SECURE YOUR CHILD’S FUTURE, WITHOUT BREAKING THE BANK
When you’re busy juggling life, kids, and endless to-dos, who has a second to think about the future, let alone save for it? But saving for your child's education has never been more critical.
When you add up everything—tuition, books, supplies, and what students need for daily life—the average cost of college in the U.S. hits around $36,436 per student each year (we’ll give you a moment). And many of our Future Funders families have more than one budding scholar to put through school.
The question here isn't just how to save, but how to save wisely.
So, let's explore how Education Savings Plans (ESAs), like 529 Plans and Coverdell ESAs, can make your savings work harder. These plans are designed to make each dollar stretch and grow, so your child can hit the books, without the weight of financial worry.
529 Plans: A Flexible Choice for Higher Education
529 Plans are state-sponsored ESAs that offer tax advantages for both college and some K-12 expenses. They come in two forms: investment plans similar to retirement accounts, and prepaid tuition plans that lock in current rates. Let’s focus on the education savings plan.
What You Need to Know
Tax benefits: Contributions grow tax-deferred, and withdrawals for qualified education expenses are tax-free at the federal level. Some states also offer their own benefits.
Investment options: 529 Plans typically offer a range of investment options, from conservative to more aggressive portfolios. It’s important to note that you don't pick individual stocks or bonds; instead, you choose from the plans' options.
Flexibility: Under most circumstances, funds can be used at any accredited college, university, vocational school, or K-12 school in the U.S. and even some international institutions. Plus, there are no age restrictions on the beneficiary.
Anyone can contribute: A 529 plan allows flexibility in who can contribute, allowing family members, friends, and others to contribute to a child's education savings.
Limitations
Qualified expenses only: If funds are not used for qualified education expenses, the earnings portion of non-qualified withdrawals is subject to income tax and a 10% penalty.
State-specific benefits and restrictions: Contribution limits and tax breaks differ by state.
Limits on K-12 education: While 529 plans can technically be used for K-12 tuition, again, not all states allow it. Plus, there’s an annual withdrawal limit of $10,000 for K-12 tuition expenses.
Qualified expenses only: Non-qualified withdrawals get taxed plus a 10% penalty.
Who It’s Best Suited For
If you aim to tuck away a substantial amount, 529 Plans are a smart choice for their high contribution limits and tax-free growth. This means your early savings can really pile up. Plus, they're super flexible, too—no age limits, and you can spend on a variety of educational expenses. This flexibility can lead to more savings and less debt, no matter where your child's academic journey takes them.
Coverdell Education Savings Accounts: For K-12 and Beyond
Coverdell ESAs cater to both K-12 and higher education expenses with tax-free growth and cover a wider expense range than 529 Plans:
What You Need to Know:
Tax benefits: Like 529 Plans, the account's earnings grow tax-free, and distributions for qualified education expenses are also tax-free.
Wide expense coverage: Funds can be used for expenses from kindergarten through post-secondary education, from tutoring to tuition.
Contribution flexibility: Anyone can contribute to a Coverdell ESA, as long as the contributor's income is below certain limits.
Limitations
Contribution limit: $2,000 per year for each child—potentially not enough for all educational expenses.
Age restrictions: Contributions are only for children under 18 and must be used by age 30.
Income restrictions: Restrictions also apply to contributors, which may limit the ability of higher-earning individuals to contribute directly (though gifting may bypass this issue).
Who It's Best Suited For
Coverdell ESAs are perfect for families who like having choices. These ESAs offer the flexibility to cover a wide range of schooling costs, from private to special education—and they also work great if you’re mindful of contribution limits. Plus, you'll be free to pick from a wide variety of investments, which means you can tailor your savings strategy to fit your family's needs perfectly.
Final Thoughts
Both 529 Plans and Coverdell ESAs offer valuable benefits for families planning for future education costs. So, when choosing between a 529 Plan and a Coverdell ESA, here’s what to look at:
Your long-term educational funding needs: Think about how much you'll need to save for your child's education in the long run and whether that matches up better with a 529 Plan or a Coverdell ESA. Better yet, use our college savings calculator.
Your investment preferences: Both let your savings grow without getting taxed, and you won't be taxed when you use the money for school costs, but they differ in what you can invest in and how you can use the money.
State-specific benefits: Check to see if your state offers any extra perks for contributing to a 529 Plan, like tax breaks, matching contributions, or scholarships.
Ultimately, this guide will help make your decision a bit easier and help ensure your child has the resources to support their learning adventure—whatever that might look like.
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