Use education savings accounts to meet college costs

Students sitting on the grass talking

It’s not uncommon for parents to place saving for future college expenses as a priority in their overall financial planning. While there are many savings vehicles that range from Share Accounts to Roth IRA Accounts, a Coverdell Education Savings Account (ESA) or a state-sponsored 529 Plan could be the easiest way to save for future college expenses. Before opening an account, you’ll want to get the basics on these savings plans. Here’s what you need to know.

What can money from a Coverdell Education Savings Account be used for?

A Coverdell ESA was established to help parents save for education costs. While a Coverdell is often associated with college tuition, parents can also use this savings account to pay for qualified elementary, middle or high school-related expenses such as uniforms or computers. LGFCU’s Coverdell ESA is not an investment account, but it earns dividends just like your Share Account.

Parents and grandparents, or even extended family and friends can open a Coverdell ESA in the name of a child. The maximum annual allowable contributions for each child is $2,000. For 2019, contributors must have an adjusted gross income below $190,000 for married couples filing a joint tax return, or $95,000 for single filers. The $2,000 contribution amount is gradually phased out if your modified adjusted gross income as a married couple filing a joint tax return falls between $190,000 and $220,000. For couples that do not file a joint return, the $2,000 contribution limit is gradually phased out between $95,000 and $110,000 annually. Confirm contribution limits for single and joint tax filers with your financial advisor.

You can open a Coverdell ESA with any financial institution. At LGFCU all it takes to get started is a $25 contribution.

Understanding 529 Plans

Like many states, and similar to the Coverdell ESA, the NC 529® Plan, administered by the College Foundation of North Carolina, is a tax-advantaged, state-sponsored education savings plan. North Carolina’s plan offers investment options covering a range of risk strategies, from conservative to aggressive. A 529 Plan lets you choose how and when to invest funds, and when to use your funds. You can be as hands-on or as hands-off as you choose with your investment approach.

These plans help your family save for future college or graduate school expenses like tuition, room and board, books and computers. Under 529 Plan rules, an account can be opened with as little as $25. Individuals can contribute up to $15,000 per year, $30,000 for married couples, on the child’s behalf and have your contributions remain excluded from the IRS gift tax.

Remember, any type of investing comes with risk. Talk with the plan administrator or your financial advisor to help you find your comfort level.

College savings tax obligations

Families focused only on saving for college may prefer the 529 Plan since it offers tax benefits not available with a Coverdell ESA. With the 529, earnings generally grow tax-free from federal and state income taxes when used for qualified expenses. The benefit of the 529 is the tax-free withdrawal of earnings built up in the plan over the years. So, if you get started early with contributions you may have built up significant earnings when it’s time to withdraw the funds. Contributions, however, are not tax-deductible.

With a Coverdell, earnings generally grow tax-free. Withdrawals are usually tax-free if the money is used for the child’s education expenses before the child turns 30. The one exception is if the child has special needs. Then, the account can continue to be funded and the money can stay in the account after age 30.

If you need to withdraw funds early from either of the accounts, you can, but you could be subject to tax penalties. Your tax advisor can help explain the tax implications.

Find your college savings strategy

If you’re planning to cover your child’s educational costs, you may not have to choose just one savings plan. Depending on your college savings goals, you may be able to contribute to both types of plans in the same year, for the same child. Use our college savings calculator to help you determine how much you may need to contribute to a Coverdell ESA or 529 Plan to meet your savings goals.

Other ways to pay for college

Keeping up with household expenses and raising children may not leave room to put money away for college savings. That means when the time comes, families must find alternate ways to pay for higher education.

“When our kids were little, we didn’t have any extra [money] to save for college,” explained member Dale J. “By the time our income had enough margin to save, our kids were in high school.”

Without a college savings safety net, Dale J. and his wife took out loans and the children applied for scholarships, including the LGFCU Scholarship. Also, each child used their savings from part-time jobs to further offset the financial aid package. According to Dale J., parents need to estimate beyond the tuition bill for a better idea of what four years of college will cost. 

“There is a focus on having enough money for the college bill each semester. It doesn’t include new tires for their cars, insurance, travel expenses, clothes, furniture for their apartment, and so on,” he explained.

Over the years, some college surveys have indicated that many parents plan to cover the entire cost of college. Instead, Dale J. suggested college-bound teens contribute their share of costs for higher education.

According to Dale, this strategy helped him and his wife manage college expenses for their children. At the same time, this approach taught his children about the value of saving and paying for what’s important to you.

“We made a deal with our kids. When they graduated and had a job, they would build into their budget to pay so much a month to me until they had paid half of what I had to borrow,” Dale J. explained.

The advice provided is for informational purposes only. Contact a financial advisor for additional guidance.

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