What Is the Best Way to Save for a Child’s College Education?
There are many options when it comes to saving for a child’s college education. Perhaps the most obvious one is setting up an account in the child’s name and regularly contributing to it. This would be known as an UGMA/UTMA (Uniform Gifts/Transfers to Minors Act) account. Once the minor comes of age (either 18 or 21), he or she takes full possession without any restrictions which naturally presents a potential drawback of this option, as not all children want to go to college when they grow up. Another disadvantage is that when determining the amount of available financial aid, the college will consider the UGMA account to be an asset of the child’s, causing it to count more heavily against him or her. Finally, the investment income (beyond the first $2,100) from this account is taxable at the parent’s rate. This is commonly known as the “kiddie tax”.
A preferable option, in our opinion, is the 529 College Savings Plan which allows for a large amount of college saving on a tax-deferred basis. Distributions from a 529 account are federal and state income tax-free if they are used to pay for qualified education expenses such as tuition, books, supplies, and room and board. Contributions to a 529 are not tax-deductible for federal taxes, but some states (including Missouri, Nebraska, Colorado, and New York) will allow a deduction for those residents that contribute to the state’s College Savings Plan. Missouri is one of the few states that allows a deduction for contributing to any state’s 529 plan.
Even though a 529 account remains under the parent’s control and is considered the parent’s asset for financial aid purposes, the IRS still treats it as a gift, so the $15,000 annual gift tax exclusion applies. A couple, however, can contribute $30,000 for each child. But wait, there’s more! There is a special provision for 529s allowing 5-year accelerated contributions, so a single parent can contribute $75,000 and a couple can contribute $150,000. Also, there are no income limits that would cause parents to be disallowed from contributing to a 529 account.
An ideal 529 plan would offer low-cost investment options from companies like Vanguard and Dimensional and keep its own administrative costs to a minimum. Thankfully, many states (including the ones mentioned above plus Texas) meet this requirement. If you need advice in setting up a 529 account, please do not hesitate to reach out to us. Clarity Fiduciary Advisors 800-345-4635.