Planning for a child’s college education can be a daunting task if you’re unfamiliar with the savings options available. When looking at the different types of college savings accounts, it’s important to consider the key features of each option and evaluate whether or not they fit your savings strategy.
Things to Consider When Opening a College Savings Account
Although the objective of all college savings plans is to provide a way to help fund your child’s education, each plan has elements that are very different and will weigh heavily on your decision. Things you should definitely consider are:
• Will the account affect your child’s ability to receive financial aid?
• How flexible are the funds?
• Is there a limit to contributions that can be made?
We’ve outlined the different types of college savings accounts below to help answer these questions to determine which option might be the best for your family.
529 College Savings Plan
A 529 plan was designed specifically for college savings and is most commonly state-sponsored. It’s important to point out that funds in a 529 account are reported when applying for financial aid. Depending on whether the student is applying through the Free Application for Federal Student Aid (FAFSA) or the College Scholarship Service (CSS) Profile, different factors of a 529 account are taken into consideration and will lower the amount of financial aid a student can receive, if not disqualify the student completely.
In addition, 529 funds can only be used for qualified educational expenses. Funds that are used for anything other than approved educational expenses are subject to income tax and a penalty fee. Although these plans will cover basic college expenses, they are not approved for other inevitable costs such as pre-college expenses, tutoring, transportation or grad school test preparation.
Contributions to a 529 account are limited by federal regulation and differ from state to state. You should assess these restrictions before committing to a 529 savings plan as this will affect the amount of money your child will have when it comes time for college.
To summarize, 529 savings plans:
• Have a high impact on financial aid eligibility
• Only allow funds to be used for qualified educational expenses
• Limit contributions depending on the state
Coverdell Education Savings Account (ESA)
The Coverdell ESA offers a way for parents to save for their child’s college education as well as K-12. Much like a 529 savings plan, an ESA will have an effect on a student’s ability to receive financial aid. The account is factored into the expected family contribution (EFC) when applying for financial aid and a higher EFC means less money awarded.
Only families that are below a certain income level qualify to contribute to a Coverdell ESA. Also, contributions to a Coverdell ESA cannot be more than $2,000 per student per calendar year. Even if a student has multiple ESAs, this amount is cumulative across all accounts and a penalty will be applied if you go over the limit.
ESA withdrawals can be used to pay for qualified educational expenses for elementary, secondary and post-secondary schools. Although these expenses cover a broad range of educational needs, ESA funds are generally less than other savings accounts because contributions are very limited. If funds are used for unqualified expenses, a 10 percent penalty will apply.
In summary, Coverdell ESAs:
• Have a high impact on financial aid eligibility
• Only allow for funds to be used for qualified educational expenses, but can be used for both K-12 and college
• Have income restrictions to open an account and are limited to contributions of $2,000 per student per year
UGMA/UTMA (Uniform Gifts to Minors Act/Uniform Transfers to Minors Act) Custodial Account
This form of savings account allows a minor to irrevocably own the funds within it. Once the beneficiary reaches adulthood (18 or 21 depending on the state), control of the account is permanently transferred to that person.
Once the funds are transferred, third parties cannot dictate how the money is spent. There are also no restrictions to how the beneficiary chooses to use the money, so there’s no guarantee that the funds will be used for a college education. Although this offers more flexibility as to what expenses the funds will cover, parents should consider the risk of giving a large sum of money to a financially inexperienced student. UGMA/UTMA custodial accounts have a high impact on financial aid eligibility as they are considered assets of the student.
In summary, UGMA/UTMA custodial accounts:
• Have a very high impact on financial aid eligibility
• Allow funds to be used for any expense, but the beneficiary has full control over how it’s spent
• Have no contribution limits
College Savings Trust
A College Savings Trust is unique from other college savings accounts because it’s considered a protected asset and funds cannot be seized regardless of parents’ financial status. The trust is treated much like a corporation – a separate “person” by law. Because of this, a College Savings Trust has no adverse impact on applications for grants, loans and financial aid.
This type of college savings offers the flexibility to cover a variety of college expenses that other savings accounts consider “unqualified”. The funds in a College Savings Trust can also be used for different types of post-secondary education, such as trade and licensing schools, offering more educational opportunities for students should they decide not to take the traditional college route.
Unlike a UGMA/UTMA account, parents can set the age of ascension for their child when they open the account. This allows for parents to continue to review how the funds are used and either confirm or deny expense requests. If there are funds left in the account after graduation, that can be used to start a business or open a practice, cover medical costs, and even pay for rent and living expenses.
Additionally, there are no limits or restrictions on contributions to a College Savings Trust. Parents can increase the amount of regularly scheduled deposits or make supplemental deposits at any time. Friends and family can easily make gift contributions directly to the account using a secure link.
In summary, a College Savings Trust:
• Has no impact on financial aid eligibility
• Allows funds to be used for a wide variety of college expenses that other savings accounts do not cover
• Has no contribution limits
Starting a college savings account for your child doesn’t have to be overwhelming. Opening a College Savings Trust can be done in just five minutes with an initial deposit of only $25. You don’t even have to wait until your baby is born to open an account! Give the gift of education with a College Savings Trust and have the peace of mind of knowing your child’s educational future is promising and secure.