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How do you start saving today for my child’s college fund?

First, ask yourself and your spouse what the end goal is. Although it may seem rudimentary to start here it’s actually quite important. Depending on how much you plan on paying for your child’s education and when you want to make contributions will help decide which savings vehicle will best meet your needs. Is the goal to pay for all or part of tuition and fees? Room and Board? Computer? 

It is also important to ensure you’re saving enough for yourself and your family to live on in retirement before funding your child’s education. Even if it’s extremely important for you to pay for your child’s education, the last thing you want is to not have sufficient money to live on in retirement as you can’t get a loan for retirement but you can for education. 

You can always pay off the loan(s) of your kid(s) if you have the financial means later in life but if you’re strapped for cash now and you’re putting your kids educational expenses first we would advise you to reconsider your goals and adjust accordingly.

If you read our article, Saving Automation 101, this will be a great guide as to how to start saving once you have the vehicle selected. Different savings vehicles have different contribution/withdrawal rules and tax incentives so picking the right one needs to be your first step. 

For those that are ready to start planning for education here are the different vehicles that can help you achieve your goals:

529 Plan – College Invest

  • 529 Plan also known as a College Savings Plan, allow for college saving on a tax-deferred basis to any eligible education institution, which is defined by the IRS as “Any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education.” 
    • Distributions from these plans are federal and state income tax-free as long as they are used to pay for qualified education expenses (tuition and fees, books, supplies, and equipment). It can also include room and board for students enrolled at least half-time and cannot exceed the greater of:
      • Allowance for room and board as part of the cost of attendance provided by the school or as part of the financial aid process
      • The actual amount charged if the student resides in housing owned or operated by the university
    • There are no income phase-outs on who can contribute to them and they can be opened to benefit anyone (family or friends)
    • You can contribute up to the annual gift tax exclusion amount of $15,000 for individuals and $30,000 if spouses elect gift splitting per year. Technically, contributors can contribute up to five times the annual gift tax exclusion amount or $75,000 as a lump sum in one year. 
    • If you’re a Colorado taxpayer, every dollar you contribute to a 529 plan can be deducted from your Colorado state income tax return (check your individual state tax incentives)

Coverdell Education Savings Accounts – Coverdell Education Savings Account (ESA) 

  • Tax-deferred account created to pay for qualified higher education or qualified/secondary  school expenses
    • For higher education expenses, they include: Tuition, fees, books, room and board, and computer related expenses. 
    • For qualified elementary and secondary expenses, they include: tuition, fees, books, supplies, equipment, tutoring, computer related expenses, and special needs services for special needs beneficiaries
    • Distributions are tax-free if qualified and taxable as ordinary income if they’re not qualified (10% penalty as well for non-qualified distributions)
    • Contributions are limited to $2,000 per beneficiary per year and are not deductible for federal or state income tax purposes

U.S. Government Savings Bond

  • U.S. Government Series EE (issued after 1989) and Series I bonds can be redeemed to pay for qualified education expenses with the interest earned on the bonds excluded from taxable income. 
    • Qualified expenses only include Tuition and fees

Other Education Vehicles of Funding

  • IRA 
    • Early (before the age of 59.5) distributions from an IRA are usually taxable at the ordinary income level and assessed a 10% penalty; however, when distributions from an IRA are used to pay for educational expenses the penalty is waived but you will still have to pay income tax on the entire distribution
  • Roth IRA
    • Contributions are considered owner’s basis and can be withdrawn at any time without tax consequences
    • Conversions represent pre-tax dollars converted to a Roth IRA (after-tax). However, you may have to wait five years from the date of the conversion to not be subject to a 10% penalty.
    • Earnings represent growth from investing contributions and conversions and can be withdrawn tax-free if the distribution is qualified
      • Qualified distributions include: withdrawals occur at least five years after the Roth was established and funded, the Roth owner is at least 59.5, becomes disabled, or passes away. 
  • UGMA & UTMA Custodial Accounts
    • UGMA (Uniform Gifts to Minors Act) allows minors to own cash or securities
    • UTMA allows minors to own cash, securities, and real estate
      • Both require a custodian of the account (usually a parent or grandparent) to manage the account for the benefit of the minor child
      • These accounts were popular before the creation of the 529 Plan
      • When the child reaches the age of majority (18 or 21 depending on the state) the child can access the account without permission of the custodian
      • Disadvantages: Once the minor reaches the age of majority the funds can be used for anything and the custodian no longer has control of the assets AND the earnings in these accounts may cause a “Kiddie Tax” issue
  •  Employer-Provided Education Assistance
    • Is a program established by an employer to reimburse employees for education expenses (may or may not be directly related to the employees current job duties and will depend on the employers policy)
    • Reimbursement up to $5,250 (2020) which is not taxable to the employee
  • Life Insurance
    • In some cases, cash value life insurance may be used as a savings vehicle for college funding especially if there is a dual need for a death benefit and a savings element
    • Speak with your life insurance agent or financial planner if using this method is something you’re interested in pursuing
  • Private Student Loans
    • Loans that are not funded or subsidized by the federal government may be available to students who need funding beyond Stafford Loans
  • Financial Aid
    • Grants, Federal Pell Grant, Teacher Education Assistance for College and Higher Education, Federal Supplemental Educational Opportunity Grant, Campus-Based Aid, Loans: Stafford Loans, Federal Perkins Loan Program, Parent PLUS, and Federal Work-Study Aid

If you don’t know which one to select or the best route to take it’s okay. This article I hope gave you an understanding of what’s available to you and their advantages and disadvantages for each. It’s extremely difficult to know what you want for your kids especially early but having a  good understanding of your earnings potential both now and in the future will help you decide whether or not you need to start now. If you don’t foresee yourself having a high earnings potential in the near to intermediate term , then maybe saving a small amount monthly now to capture the value of compounding is a better choice then trying to put together a lump sum later. 

If you’re already not saving enough for yourself for retirement then you need to prioritize that before you start saving for a cost that a loan can pay. 

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