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How to Save for Your Child's Education

How to Save for Your Child's Education

Posted on 12/31/2013

There are numerous options available to save money for your child’s education:
  • 529 college savings plans: State-sponsored 529 plans are investment plans that allow you to contribute after-tax money for your child's future college tuition. You can choose between a variety of investment options for your funds according to your risk tolerance and investment when you need to access the funds. Anyone can contribute to the plan (i.e. parents, grandparents, extended family) and the earnings in the plan grow tax-free. The contribution limit over the life of the plan is $300,000 (including interest earnings). You can then withdraw money tax-free from the account when it comes time to pay for college-related expenses. However, if you use funds for non-college related expenses you have to pay tax and a 10% penalty on earnings.
  • Coverdell education savings accounts (ESA): $2,000 may be contributed each year (for each of your children) to a Coverdell ESA to help pay for your child's elementary, secondary school and/or college costs. You choose how your money is invested; the money you earn on your investment grows tax-free and you do not have to pay taxes when you withdraw money from the account for qualified education-related expenses. There are income limits to be able to qualify to contribute to a Coverdell ESA. Anyone whose income qualifies can contribute to an account (i.e. grandparents, family friends), however there must be only one “responsible individual” to oversee the account and the total annual contribution for each child cannot exceed $2,000. Contributions are not tax-deductible, however there are tax-free withdrawals. The amount of scholarship money your child receives is deducted from the allowable expenses for the Coverdell ESA. So, if qualified education expenses are $10,000, but the child received an academic scholarship for $6,000, you’d only be able to make a withdrawal of $4,000. Unused funds may be rolled over into the Coverdell ESA of a family member (beneficiary must be under the age of 30 at the time of the rollover).
  • Prepaid tuition plans: With prepaid tuition plans you pay into an account managed by either a state or a specific college. Your funds are bundled with other contributors and invested to earn a return, which will hopefully outpace the rising cost of college tuition. Your withdrawals are exempt from federal taxes and perhaps from state taxes as well, as long as you use the money to pay for qualified college-related expenses. However, if you withdraw the money for non-college related expenses the funds will be taxed and you will also have to pay a 10% penalty on money your investment earned. If your child chooses to attend a different school (if you're paying into a school-specific plan) or an out-of-state college (if you're paying into a state-managed plan) you will not be able to recover all of the money you have invested.
  • Custodial accounts: The Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) allow you to deposit up to $10,000 tax-free each year in an account to be used for your child's education. The account is in your child's name but managed by you until the child reaches 18. While the child is a minor, money in the account can be used for college or any other expenses for your child; however the account becomes the property of your child when s/he reaches 18 and at that point they can use the funds for any purpose.
  • Saving bonds: U.S. Treasury EE savings bonds are backed by the federal government and guarantee a fixed rate of return. Bonds can be redeemed to pay for qualified college expenses and the bondholder does not have to pay income tax on the interest earned. There are income limits to qualify for the tax exemption and the bondholder must be at least 24 years old. You are limited to purchasing $5,000 in EE bonds in one year; you can purchase EE bonds in a variety of denominations (between $50 and $10,000) and buy them online through the U.S. Treasury's website (treasurydirect.gov). A student may have up to $3,000 in their name before it affects the qualified amount of financial aid.
  • Certificates of Deposit (CDs): If your child is turning 18 in less than 5 years and you’d like the flexibility of a short-term investment, consider a traditional 6-60 month CD at SCCU. Funds may be used at your discretion for any type of savings and does not have to qualify as an education expense. If you open the CD in your child’s name, remember that the account may affect financial aid eligibility. CDs must be fully funded at the time of opening. Annual percentage yield is fixed for the term of the deposit. Bonus rates are available based on member rewards level.
  • Roth IRA: Contributions to Roth IRAs have no effect on the contributions you can make to a Coverdell ESA. You are able to have both accounts. Annually contribute up to $2,000 to a Coverdale ESA and up to $6,000 to a Roth IRA with after-tax money and received tax-fee withdrawals. Open a Roth IRA at SCCU for only $100 and no minimum yearly deposit or maintenance fees. You do not have to pay federal taxes on the earnings if you have waited at least five years since contributing, otherwise if you are under 591/2 and have not met these requirements, you must pay taxes on your profits as well as a 10% penalty. College living expenses and tuition are qualified expenses. Income restrictions apply. Couples who earn less $176,000 or singles who earn less than $120,000 can contribute $5,000 a year (or $6,000 if over the age of 50). Note, the amount you withdraw will be added to your taxable income for the year. This could be enough to put you in a higher tax bracket. Even if your retirement is years away, you'll need to consider the impact of the withdrawal on your retirement plans. However, you may have time to reconcile the loss and perhaps even compensate for it by increasing your payback after any withdrawal (subject to annual contribution limits). If the IRA is your sole retirement fund, you'll want to investigate alternatives (e.g., financial aid, grants and loans) before withdrawing money. After all, a withdrawal close to retirement may impact your plans.
As you can see, there are many options available to invest savings for a child’s education. The key is to start saving early. The longer your money has to grow, the more it will gain compound interest. If you begin investing when your child is born, you could contribute less money annually and end up with much more money than if you waited to save until the child was 10 years old.

To illustrate the power of compounding interest, we used an annual return of 10% which comes from the average return of the broad stock market. Some plans will return less and will vary from year to year. This is for illustration purposes only and does not take into account additional tax savings or credits that can be obtained. For more information, contact a financial advisor.
  • Begin investing $2,000 a year when your child is 10 years old in an account that earns 10% annually. This would result in a total savings of $25,158.94 by the time the child is 18. Total money invested: $16,000.
  • Begin investing $2,000 a year when the child is born, would result in a total savings of $79,089.35 in 17 years. Total money invested: only $34,000.

As you can see, you would end up with 53,930.41 more if you started saving 10 years earlier.

This article is not intended as tax advice. Please contact your financial advisor for more information.

About Space Coast Credit Union

Space Coast Credit Union was chartered in 1951 and is headquartered in Melbourne, Florida. The Credit Union serves over 239,000 members with assets of over $3 billion through a network of 57 branches and over 100 ATMs located throughout Florida and through its web site, SCCU.com. Space Coast Credit Union is open for membership to anyone who lives or works in the Florida counties it serves.
  • SCCU Routing Number: 263177903
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Space Coast Credit Union membership is open to all who work or live in Brevard, Broward, Flagler, Indian River, Martin, Miami-Dade, Monroe, Orange, Osceola, Palm Beach, Seminole, St. Johns, St. Lucie, or Volusia Counties in Florida.
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