A college education costs a lot of money. It is a fair bet that it will cost even more next year, and the year after that, and the decade after that.For parents, the thought of writing checks for upwards of $60,000 a year for four years or more can send shivers down the spine. But a child so overwhelmed by student loan debt that they have to move back home after earning their expensive degree isn’t an attractive option either.
Marshaling the resources for such a significant investment requires more than building up your savings account. You’ll need all the help you can get – such as earned interest and capital gains, and minimized tax liabilities with maximized tax benefits.
There are two primary vehicles parents can use to optimize their college savings efforts: a UGMA/UTMA account or a 529 college savings plan. Each option offers pluses and minuses, but both are much better ways to get that college spirit going than a traditional savings account or the distant hope of a full scholarship.
UGMA and UTMA Accounts for College Savings
An old-school but still very much vital college savings tool is a custodial account created under the Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA).
Advantages& Disadvantages of UGMA and UTMA Accounts
Parents or others fund these accounts and hold them for the benefit of a minor child. Once the account is established, the beneficiary cannot bechanged. There are no contribution limits on UGMA/UTMA accounts, and the amounts held in the account are considered assets of the child. This has two important implications:
- any earnings or capital gains are subject to the “KiddieTax,”
- and colleges will consider these accounts when calculating financial aid packages, thus likely reducing the amounts offered.
While parents often use UGMA/UTMA accounts as a way to fund their child’s college education, they are not technically college savings plans. There is no requirement that the funds be used for educational expenses.
While the funds must be used for the child’s benefit while he or she is a minor, the child takes full control of the account when they turn 21(for accounts in Illinois; the age is 18in some other states). At that point, the now-grown child can choose to spend the money on tacos instead of tuition and tax authorities won’t care at all. Parents, on the other hand, may not be too happy about such a decision.
529 College Savings Accounts
If you want to ensure that your college savings will, in fact, be used for college – and ensure that you’ll pay a hefty penalty if it isn’t – a 529 account can make that happen.
The accounts are often run by individual states; in Illinois, the state manages the “Bright Start” college savings program.
Benefits of 529 College Savings Accounts
Funds contributed to 529 accounts grow tax-free. Withdrawals are also tax-free if used for qualified expenses, which include tuition, books, and room and board. The funds can be withdrawn without tax liability to pay for such costs at two-year and four-year institutions, including vocational, trade, community, state, or technical schools.
Bright Start 529 Tax Deductions in Illinois
In addition to earnings and qualified withdrawals being tax-free, joint-filing parents or others in Illinois who establish a Bright Start college savings account can deduct$20,000 each tax year ($10,000 for individual filers) for their total, combined contributions to the account.
But if money is withdrawn and used for anything other than qualified expenses, it will be subject to federal income tax and a 10 percent penalty, and the state of Illinois can recapture any amounts previously deducted for tax purposes.
529 Accounts vs UTMA & UGMA Accounts
One distinction between UTMA/UGMA accounts and 529 accounts is that with the former, account holders have the full universe of investment options at their disposal while 529 plans typically offer a limited menu of investment options.
Let Us Help You With Your College Planning
Which college savings option is better for you depends on your individual circumstances and goals. But if you want to jump start your child’s college funding, either choice is better than doing nothing.
If you have questions about how to optimize your college savings, please contact us. We welcome the opportunity to assist you.