7 Types of College Savings Accounts
The idea of saving for college can be overwhelming. This is because when many parents think about saving, they (mistakenly) believe they need to put aside enough money to pay for 100 percent of college. In reality, most families use a combination of savings, financial aid, scholarships, and student loans to pay for college.
Beyond deciding how much you can afford to save each month, you also need to figure out where to save your money. Here is a list of seven types of college savings accounts you may want to consider.
Most financial experts agree that 529 plans are one of the best ways to save for college. Most states, including North Carolina, have 529 plans. They’re tax-advantaged education savings accounts that are not subject to state or federal taxes. Individuals can contribute up to $15,000 per year, per account, without triggering the gift tax.
The money grows tax-free if the funds are used to pay for qualified education expenses. Eligible expenses have recently been expanded and now include all of the following:
- College expenses, including tuition, books, fees, room and board, a computer and more
- Trade school expenses, as long as they are on the Federal Student Aid list
- Apprenticeship program expenses, for programs registered with the US Dept of Labor or State Apprenticeship Agency
- Special needs equipment
- K-12 tuition expenses up to $10,000 of 529 funds per year, per child
- Student loan payments on behalf of the 529 beneficiary or beneficiary’s siblings up to $10,000 per individual.
A Coverdell education savings account (ESA) is also a tax-advantaged education savings account. Just like 529 plans, the earnings grow tax-free when the withdrawals are used for qualified education expenses. However, Coverdell accounts have a $2,000 annual contribution limit per child.
Many parents first discovered Coverdell ESAs while searching for ways to save for elementary and secondary private school tuition. Now that many state 529 plans, including NC 529, allow families to use the funds for K–12 tuition, some parents are transferring accounts to take advantage of the higher annual contributions.
Another type of college savings account is the custodial account. The tax advantage of this type of account is that the earnings are taxed at the child’s tax rate, which is usually much lower than the parents’ rate. Individuals can contribute up to $15,000 per year, and couples can contribute up to $30,000, without triggering a gift tax.
Generally, these types of accounts transfer control to the child once they turn 18 or 21, depending on the rules in your state. That means the child can withdraw funds for anything they want, including non-education expenses.
Prepaid Tuition Plans
Prepaid tuition plans allow families with young children to lock in and pay tuition rates at today’s prices. The benefit is realized when the child attends college, presumably years from now, and their tuition is already covered. That can be a big cost saving with the rising price of tuition.
Not every state offers a prepaid tuition plan, and in most states, the money must be used at in-state schools to get the full benefits. And prepaid plans don’t cover the cost of room and board or other non-tuition related expenses.
Traditional Savings Accounts
Many families already have individual savings accounts at their local banks for each child. So, when grandma or grandpa sends a check for their birthday, some or all of the gift is deposited into that child’s account.
The benefits of traditional savings accounts are that it’s easy to make deposits, and if your child gets a part-time job in high school, they can easily continue adding to the savings. However, most bank savings accounts earn low interest rates, so the money will not grow as much as it can with other saving options.
Savings bonds are issued by the U.S. Department of the Treasury and are guaranteed by the federal government. Interest from bonds is usually tax-free if they’re redeemed to pay for higher education expenses.
They’re sold in different amounts and with various rates of return. Some bonds can be redeemed for double the amount of the original purchase price. However, it could take up to 20 years for some bonds to mature.
Investing in the stock market can be a beneficial way to save for college if you know what you’re doing. Trading stocks is considered a high-risk investment with the potential for high gains or big losses. It’s not for the faint-hearted and you’ll need to be ready to weather the storms of market swings.
A broker or financial advisor can help you manage your stock portfolio to maximize earnings. There are no tax advantages to saving for education with stocks. You will have to pay capital gains on the earnings. That amount varies, depending on your income bracket.
Talk with your tax advisor for more information about which types of college savings accounts are right for your family. You’ve already taken an important first step and started researching the different types of savings accounts.
To give you a better idea of how your savings can grow, check out the NC 529 Plan calculator. Simply plug in how much you want to save each month and how many years until your child will need the money for their education. The calculator can help you set savings goals to be prepared for the future. You can also find answers to common questions about saving for your child’s education with NC 529.