Saving for Education Expenses
For millions of Californians, funding an education is an important goal that requires a lot of planning. Even at the elementary school level, parents must consider school supply lists and the additional tools needed to aid their children’s learning.
Long-term saving for college and other education expenses is a two-horse race to the finish line these days. Prior to 2013, state-sponsored 529 plans (named after a section of the Internal Revenue Code) were the best college savings choice for families because of their investment options and tax advantages.
But the American Taxpayer Relief Act signed into law on January 2, 2013, enhanced the Coverdell Education Savings Account (ESA) as a viable tax-free savings option that can be used on educational expenses as early as kindergarten. Depending on your goals and how the savings account will be used, you could benefit more from either a 529 or ESA so it’s important to understand their details, benefits and restrictions.
Synopsis of the 529
California and most states offer their own 529 plans, but you don’t necessarily need to live in a particular state to invest in its plan. Often the 529 plan in your state of residency offers the most tax advantages, but take some time to research the differences. The most popular 529 option structures the plan as a savings account that offers different investment portfolios. Some portfolios are age-based, meaning early on you’ll invest aggressively in growth-based securities such as U.S. and international stocks and then the portfolio automatically reallocates to more conservative investments as the child approaches college age. Another choice is to create an individualized portfolio in which you determine your investment strategy and adjust it as necessary to meet your risk tolerance. Investment options are determined by the investment company that administers the state program.
There’s also a prepaid option for the 529 plan that allows you to purchase tuition credits for a specific university at today’s price. This might be a good idea if you know exactly where your child will attend college.
Inside the ESA
Coverdell ESAs are gaining popularity because they offer many of the same tax advantages as 529s and the accounts can be used for any qualifying expenses between kindergarten and college, including tuition, books or computers. ESAs were in limbo until tax laws in 2013 solidified their benefits to participants.
ESAs rely on securities investments in stocks, bonds and mutual funds to help families save more money for education expenses.
Some Similarities of 529 Plans and ESAs
- You control your investments.
- Earnings are tax-deferred.
- Contributions are non-tax deductible for federal income tax purposes.
- Withdrawn funds are federal income tax-free if used for qualifying educational expenses.
- Assets can be transferred to another family member.
- Assets within a 529 plan or ESA may affect your child’s access to financial aid.
Some Differences Between Education Savings Plans
- $2,000 annual contribution limit.
- Contribution deadline is the tax filing date for a given year.
- Income limits for contributors begin at $190,000 for married taxpayers filing jointly.
- Assets must be used or distributed by a beneficiary prior to age 30.
- Assets can be used for elementary and secondary education expenses, not just college.
- Annual contribution limits vary, depending on the state sponsoring the plan.
- No income limit for contributors.
- No age limit on the use of assets.
- Assets can be used only for eligible expenses at accredited public or private colleges or universities.
- Portfolios are administered by investment companies.
Several other differences exist between 529 plans and ESAs. Research as much as possible to find the best education savings option for your family, and consult your tax advisor for accurate information about state and federal tax advantages.