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Q: We recently had a baby. How can we begin saving for our child’s future higher educational expenses? We’re concerned that we can’t save enough if we don’t begin immediately. What have you heard about the 529 savings plan?
A: Congratulations on getting an early start! With the rapidly rising costs of higher education, it’s never too early to start saving money for your child’s education. There are several options for setting aside money for future educational expenses. Consider your options carefully and base your decision on your situation.
Start saving for your child’s educational expenses today:
- 529 savings plans have many advantages. A 529 account allows your contributions to grow tax-free, though the contributions are not tax-deductible. The distributions are free from taxes, provided the funds are used for education expenses.
- You are eligible for any 529 plan, regardless of your state of residence. Ensure that you consider the details of each policy before making a decision.
- The money remains under the control of the person that creates the account. You can always take your money back at any time. You will be taxed on the gains, however, if the funds aren’t used for education.
- Different plans have different investment options.
- Custodial accounts are a unique way to save for your child. This type of account is a savings account with investment options. You control the account until the child is legally an adult. The first $850 of earnings each year are untaxed. The next $850 is taxed at your child’s tax rate. Any gains beyond that amount are taxed at your rate.
- Coverdell Education Savings Accounts are another option. These accounts are analogous to an IRA, but the funds are used for educational purposes instead of funding your retirement. Annual contributions are limited to $2,000, and the contributions are after-tax. The gains and the distributions are tax-free. The funds can be applied to any accredited school for grades K-12, as well as for higher education.
- Many states provide the option of pre-paying your child’s tuition. You can pay for your child’s education today at the current tuition costs.
- Though there are exceptions, in most cases, the money can only be applied to public schools in your state or the state of the person opening the account.
- Some plans will permit the funds to be used for an out-of-state school, but will only cover the costs for an in-state student. The added value of being an out-of-state student won’t be covered by the plan.
Which method makes the most sense for you and your child? A 529 savings plan is the most flexible option and permits a lifetime contribution of at least $235,000. Whichever option you choose, the most important factor is to get started right away.