It’s the middle of summer and for some parents, that means back-to-school shopping is right around the corner. New textbooks, erasers, coffee cups, clothes – the list goes on.
But amid all the excitement involved in these rites of passage, many parents are worrying about being able to afford college tuition for their children when the time comes. While some parents plan to finance their tuition payments through loans, others want to plan ahead for this monumental occasion in their children’s lives. So, let’s talk about two great savings vehicles for parents who are looking to maximize tax advantages while funding their kids’ college education.
How and Where to Save for College
We know that as you take your child home from the hospital, the weight of caring for them and what it entails can be daunting and we hate to add another thing to your list. But believe it or not, you’ll want to start saving as soon as your child is born.
The best answer is start early and save often. Using an 18-year time horizon will make the burden of saving for college much less stressful since you can use compounding interest to your advantage. For those of you starting early, here’s a list of tax advantaged savings vehicles that will help supercharge your college savings goals:
529 plans are the most common savings vehicle for college; they’re like IRAs except for education rather than retirement. You contribute money to the 529 plan as a “gift” and it grows tax deferred until it’s distributed for qualified college expenses such as tuition, books, and room and board. The maximum each parent can give is $15,000 per year, and while there are more nuances to max contributions and ways to “overfund” 529s, such details are beyond the scope of this article. (Please feel free to reach out to us and learn more about the nuances of funding these plans if you’d like to contribute over $15,000 per year.)
While the tax-deferred status is useful, it’s worth noting there’s another benefit to 529 plans. Technically, a 529 is owned by the beneficiary. This makes 529s not only a good college savings strategy but also a great estate planning strategy by shifting assets out of your name into the names of the beneficiaries. This is something to consider if you have recently come into a lot of money or the child’s grandparents are looking to distribute some of their assets before they pass. It’s also worth pointing out that while 529s are meant for college expenses, you can spend $10,000 per year on k-12 private school tuition. This can be advantageous for parents who are figuring out how to pay for private school education for their kids.
It seems Roth IRAs could be a solution for just about everything. Their flexible nature and tax-free status help people find creative ways to use them for funding needs other than just retirement. One of those needs can be college tuition.
Roth IRAs offer no tax incentives when money is contributed, but the post-tax money contributed to Roth IRAs then grows tax free and has no tax impact when taken out in retirement. Interestingly, Roth IRAs can be used as hybrid savings vehicles for college and retirement, and while there are usually penalties for disbursing money before age 59 ½, this penalty is waived for college expenses. While the tax consequences of using your Roth IRA for college can be complicated, it’s much more advantageous than using a traditional IRA. (Please reach out if you’d like to have a deeper understanding of the tax implications for using a Roth IRA for college expenses.)
Roth IRAs can be perfect for parents who are unsure of what their children’s educational future looks like. While 529s let you save more, they must be used for higher education or you’ll pay a 10% penalty and income tax on the gains in the account. For parents who are both focused on building their personal nest egg and wanting supplemental coverage for their children’s college expenses in a tax efficient manner, Roth IRAs can be a great option.
Other than retirement, providing your kids with a college education is the biggest savings challenge for parents over their lifetime. It’s critical to know your options so you can feel at peace knowing you’ve set your children up for success. With so much stress surrounding how and where to save for your children’s education, you need to have a plan in place to maximize the efficiency of each dollar saved.
Understanding some of the options available to you will help you understand which savings vehicle makes the most sense for your unique needs. At Denver Private Wealth Management, we aim to educate our clients on their options and to put a plan in place to achieve their goals. Please feel free to reach out if you have any questions.
Denver Private Wealth Management is an independent fee-based financial planning practice with 50+ years of experience in the financial industry. DWPM customizes portfolios based on your financial goals and works closely with you, your tax advisors and estate attorneys to form a comprehensive view of your financial situation. For more information or to set up a free consultation, contact us at firstname.lastname@example.org.
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