When you’re busy worrying about how to make ends meet, college savings is the last thing on your mind. It’s important to keep in mind, however, that you have options — even when it feels like college is a distant fantasy for your child.
Even a small monthly investment adds up over time and reduces your out-of-pocket college costs. The key is making the commitment and making a plan. Let’s dive in!
Tax-free option: Coverdell Education Savings Account
The Coverdell Education Savings Account (ESA) lets you set aside up to $2,000 of post-tax dollars annually toward a student’s education expenses incurred in the elementary, secondary or college years. The account grows free of federal income taxes, and withdrawals used to pay the beneficiary’s qualified education expenses are tax-free, with some caveats. Some portion of an ESA withdrawal may be taxable — for instance, if a family is claiming the American Opportunity tax credit or Lifetime Learning credit.
- Offset the costs of not only higher education, but also elementary and secondary school
- You’re free to choose the investments you want to put into the account
- You can change the beneficiary if needed, penalty-free
- Simultaneously contribute to both a 529 plan and a Coverdell ESA in the same year for the same beneficiary
- Coverdell ESAs are treated as parental assets for purposes of financial aid, and distributions are not considered parent or student income
- The annual contribution limit is $2,000
- Contributions cease after the student reaches age 18, unless the beneficiary has special needs
- Any withdrawals from a Coverdell ESA that are not used for qualified education expenses are taxed and penalized
- There may be fees charged from the financial institution for maintaining the account
Tax-deferred option: Roth IRA
If you like the idea of protecting your money from taxes, a Roth IRA can be a good option. With a Roth IRA, you contribute after-tax dollars and are allowed tax-free withdrawals of those contributions for children’s college expenses.
- You pay no extra federal taxes if you withdraw the amount of money you contributed
- You pay no federal taxes on the earnings or profits spent on college tuition
- Fund companies may require minimum initial payments, such as $2,500 a year or $200 a month
- Although relatives can contribute to a Roth IRA, they might be more likely to donate to a specific college fund rather than your retirement fund
- You cannot deduct contributions from federal income taxes
Regular savings account
If you’re new to the concept of saving money, a regular savings account is an easy, hassle-free way to get started. You can drop by your financial institution and set it up today with a minimal initial investment.
- Low minimum deposit in most cases
- Easy access to your money if you need it
- Interest accrues on money that otherwise would be sitting in your wallet or checking account
- Easy access to your money (too easy to withdraw anytime an expense comes up)!
- Lower returns than many other forms of college savings
- No tax benefits; pay tax on interest
Why bother? I can’t afford to contribute.
You’d be surprised how much you can save if you simply cut back in other areas. That $4 latte won’t taste as good if it means sacrificing your child’s future, so the key is to change your habits and thinking.
Consider this: If you set aside just $50 per month when your child is born, you’ll accrue $21,000 by the age 18, assuming a 7 percent interest rate.
Every little bit helps.
You can’t afford not to fund your child’s college education. Even with no investin g experience and a small budget, you can set aside moderate amounts each month. And when it comes time for college funding, you’ll be ahead of the game.