The best place to start when thinking about saving for college is to open a college savings plan. College savings plans, also known as education savings plans, are tax-advantaged investment vehicles similar to Roth IRAs.
There are two primary types of college savings plans: the Coverdell Education Savings Account and the 529 College Savings Plan. But which is best for you? Let's jump into it!
The 529 College Savings Plan
When it comes to saving for college, investing in a 529 plan is one of the best ways to ensure that you are able to afford the education that your children will need to succeed in life.
An education savings plan is a type of 529 plan that can be used for any educational expense, whether it’s college tuition, a university textbook, or certain extracurricular activities.
The other type of 529 plan is a prepaid tuition plan, which is an account invested in the state’s tuition program. The money in these accounts is used to purchase tuition units, which can then be used to pay for college tuition.
The 529 College Savings Plan is the most popular type of 529 plan because it is tax-advantaged and can be used for any educational expense.
There are two ways to contribute to a 529 plan: You can either make a contribution to the plan through your own money or you can make a contribution to a 529 plan through your employer. Contributions to a 529 plan are not tax-deductible.
529 College Savings Plan Pros:
- Contributions to the plan can be used by the student or child at any time throughout his/her life.
- There are no income restrictions.
529 College Savings Plan Cons:
- Non-educational expenses are still taxed.
- Contributions can only be used for qualified educational expenses.
The Coverdell Education Savings Account -
The Coverdell education savings account is the second most popular type of plan. Like the 529 College Savings Plan above, the Coverdell Education Savings Account can be used for any educational expense.
The biggest difference between the Coverdell Education Savings Account and the 529 College Savings Plan is that the Coverdell Education Savings Account is only available to parents who have children.
When opening a Coverdell Education Savings Account, the money is placed in a separate bank account that can be used for any educational expense.
The Coverdell Education Savings Account contributions can only be made by the parent or guardian, not by an employer, and contributions can only be made with after-tax money. These contributions are not tax-deductible unless used for qualified educational expenses.
Coverdell Education Savings Pros:
- Offers tax-free withdrawals when the funds are spent on qualified education expenses.
- Can be used for all education levels (primary, secondary, post-secondary.)
Cons:
- Income restrictions mean the ability to contribute to a Coverdell account is limited by the modified adjusted gross income set for a given tax year.
- Contributions are limited to just $2,000 per child each year.
- Contributions must be used by the time the student has turned 30 years old, in order to avoid penalties and taxes when withdrawing money.
So, should you choose Coverdell Education Savings or a 529 Savings Plan?
It’s important to think about your financial situation, your outlook on investing, and what will be best for you.
If you have a lot of money available to invest, then the 529 College Savings Plan is likely the best option for you. If you know that you have a lot of expenses coming up, then the Coverdell Education Savings Account is the best option for you.
The important thing is to start investing today to ensure that you will have enough money to pay for your children’s education in the future.
As always, do your own research and make the best decision for you and your projected outlook on your life and your children’s life!
