How to Save for Your Kids’ Future – Visionary Wealth Advisors

How to Save for Your Kids’ Future

Katie Martin, CFA, CFP®

May 4, 2021

With the graduation season right around the corner, college might be on your mind. Maybe its reminiscing about fun times from your own college experience – we all know those stories NEVER get old. Or, if you’re like me and some of those memories are starting to fade, planning for your children’s college experience might be top of mind. One of the first thoughts we often have is that it’s going to be expensive, and how are we going to pay for it?

Saving for their children’s future is a key goal for many of my clients. There are several different ways to save your kids, and each can play a unique role. Let me break down a few options for you, along with some of the most common questions I hear from my clients regarding these accounts.

529 College Savings Plan Education Savings Account (Coverdell Account) UTMA/UGMA Account (Custodial Account)
What is this? This is designed for saving for your child’s education. This is designed for saving for your child’s education. You can think of this as an investment account for your kids. It’s a way to save for any future expense they might have and isn’t specific to education.
What does the name mean? 529 plans are named after Section 529 of the Federal Tax Code, which is the section of the tax code that authorizes them. ESAs are sometimes referred to as Coverdell Accounts after the Senator that championed their establishment. UTMA stands for Uniform Transfers to Minors Act, which is the act that allows a minor to receive gifts of money.
Who has control over this account? The owner (typically a parent or grandparent) The owner (typically a parent or grandparent) The custodian (typically a parent), but it becomes the child once he reaches the age of majority. This is 18 or 21, depending on the state.
How much can be put into the account? A lot – most plans allow for $200,000 or more in contributions over the life of the account. That said, you’ll need to keep annual gift tax limits in mind (although there are some nuances with this.) $2,000 a year. A parent’s ability to contribute begins to be phased out once they reach income limits ($95,000 for single filers and $190,000 for married filing jointly.) As much as you want, but you’ll want to keep in mind annual gift tax limits.
How can this money be used? Qualified education expenses – tuition, room & board, and computers are examples – at colleges, universities, community colleges, and trade schools.

 

Up to $10,000 a year can be used for K-12 education.

 

Up to $10,000 for student loan repayment.

Qualified education expenses – tuition, room & board, and computers are examples – for post-secondary or K-12. Anything that is for the child’s benefit (such as education, summer camp, a car, etc.) Once the child reaches the age of majority, they can use it however they want.
How do taxes work on these accounts? Money grows tax-free and can be withdrawn tax-free if used for qualified education expenses.

 

Depending on the state you live in and the plan you are using, contributions may be able to be deducted from your state income taxes.

Money grows tax-free and can be withdrawn tax-free if  used for qualified education expenses.

 

No tax break on contributions.

These accounts do not grow tax-free and any income or withdrawn earnings are taxed. The tax rate depends on the age of the child when money is distributed from the account, as well as the amount of earnings withdrawn.
How does this impact financial aid eligibility? Treated as an asset of the parent (if the parent is the owner), which has a smaller impact on financial aid eligibility. Treated as an asset of the parent (if the parent is the owner), which has a smaller impact on financial aid eligibility. Treated as an asset of the child, which may have a greater impact on whether the child qualifies for financial aid.
What if my child decides he/she doesn’t want to go to college? You can change the beneficiary to a sibling or other relative (including yourself, if you’d like to go back to school.)

 

Money can always be taken out of the account for another purpose, but earnings will be taxed as ordinary income and may be assessed a 10% penalty.

You can transfer unused funds into another Coverdell account for a relative of the original beneficiary. You can also transfer them into a 529 plan.

 

Unused funds must be distributed when the child reaches age 30. They’ll be taxed and assessed a 10% penalty.

No impact since these accounts aren’t limited to education.
What if my child gets a scholarship (besides celebrating of course?

 

Like above, you can change the beneficiary to a relative.

 

Since there’s no age limit on 529s, you can continue to keep the funds in the account until you have a use for them (such as graduate school down the road or even a future grandchild.)

 

You can also withdraw up to the amount of the scholarship without being assessed the 10% penalty, but earnings will still be taxed.

Like above, you can change the beneficiary to a relative (under age 30.)

 

The scholarship reduces the “qualified education expenses”, which is the amount of money that can be withdrawn. Any money withdrawn for reasons other than education is taxed and assessed a 10% penalty.

No impact since these accounts aren’t limited to education.

It’s important to note these accounts aren’t mutually exclusive – you might have a 529 plan to save for your children’s college and a small UTMA to help them start learning how to invest. A trusted financial advisor can help you figure out how these accounts fit into your overall financial plan.

Having a plan in place can make the thought of paying for your kids’ future much less daunting. Now, if only there was a math equation I could use to get me through the teenage years…