How To Save for College Without Using a 529
When it comes to college savings, there’s no shortage of confusion….
What will college cost when they get there?
How much debt will they/you need to take on?
What is the best way to save for their college?
When is the best time to start saving for college?
It’s great that you’re here right now, because that means that you’re thinking about your child’s college education, and ready to find the best ways to save for it.
But what about if you’re not sure your child will even attend college and you still want to set aside some money for them later in life?
After all, there are tons of valid career paths that don’t require attending college!
My husband and I are in this boat, wanting to save money that CAN be used for college, but that doesn’t HAVE to be used for college (without penalty, that is)
So, if you’re in our shoes, what do you do?
First up, you need to pick the right savings vehicle. Picking the wrong one could mean that your child misses out on financial aid opportunities, or costs them tons in taxes that could have been avoided.
Financial Aid is usually determined from the parent’s and student’s income and assets during the student’s Junior year of high school, but the student’s income and assets carry greater weight than their parent’s, so when at all possible, it’s usually more advantageous to keep college savings in the parents names (using tax-advantaged savings accounts) to avoid missing out on financial aid.
But the flip side of choosing a college savings vehicle is that you can use one to your and your child’s advantage to make their college experience a less painful, and hopefully debt-free one.
There are 4 main savings vehicles that will work well in this situation:
- UTMA & UGMA Accounts
- Roth IRA
- Traditional IRA
- Mutual Funds/Traditional Investments
UTMA & UGMA Custodial Accounts
If you’re unsure of whether your child plans to attend college, or for another reason is not at risk of losing financial aid because of assets in their name (financial aid looks at how much money the student has to his/her name as part of the equation to determine how much aid they get), then a 529 or Prepaid Tuition Plan is not a good option. These plans lock money into only being used for educational expenses, but you want more freedom than that.
UGMA stands for Uniform Gift to Minor Account.
UTMA stands for Uniform Transfer to Minors Act.
In these accounts, the taxes get a bit complicated:
- First $1,000 in gains is tax-free
- Second $1,000 is taxed at the child’s income tax level.
- The remainder is taxed at the parent’s income tax level.
In these accounts, there are no restrictions as to how these funds may be used, provided they are used to benefit the child.
However, there is a downside.
In UGMA and UTMA accounts, the parents have no control over the money after the child reaches the age of 18, because under the law the money is theirs. While the child is a minor, the parents controls the money.
If you want to give your kids a head start on retirement savings – that could be used for college if necessary, with minimal tax impact – opening a Roth IRA for them is a great option.
Once he or she begins earning an income, they can have a Roth IRA, and 100% of their income, up to $5,500 can be deposited in the account, which will grow tax free.
The downside is that the funds deposited in a Roth IRA are post-tax, so an income tax return must be filed at the end of the year for the child, and taxes paid on their income.
While your child is under 18, you retain control of the accounts, but after 18, control reverts to the child. However, the law requires that withdrawals not be made from a Roth IRA until the age of 59 1/2.
With that being said, Roth IRA funds can be withdrawn without penalty for a few reasons:
- Education expenses
- Purchasing a first home
- and others, found here
You can find easy-to-manage Roth IRA accounts at Betterment.com.
You can open a traditional IRA account in your child’s name if they meet the following criteria:
- They have a taxable earned income
- their income is less than $117,000
- they are under the age of 70 1/2 (lol)
Funds deposited into a Traditional IRA are deposited pre-tax, and taxes are only paid when the money is withdrawn after age 70.5, at the account holder’s current tax bracket.
So how can these funds have the option to be withdrawn for college expenses? There are a few penalty-free withdrawal options:
- College costs
- First Home Purchase
- Medical Expenses
- Health Insurance
- and more, found here.
The best place to open an (easy to use, easy to understand, and easy to manage) Traditional IRA is with Betterment at Betterment.com
Traditional Investment/Mutual Fund
Investing for your child via a traditional investment/mutual fund is basically the same as a traditional IRA. They have to earn an income and meet the criteria above, the only difference is that contributions are post-tax, and gains are taxed as well.
You can open these accounts in the child’s name – or with them if they’re old enough – and funds can be withdrawn almost as often as you wish, for whatever purpose you wish.
You can find great investment options at Betterment.com
Here’s the lowdown….
Some parents may not want to save for their child’s college. (We are actually in this camp).
We would like our daughter to “embrace the struggle” of college by applying for as many scholarships as possible, working during high school and college, keeping her living expenses low, and being mindful of the costs at the college she chooses to attend – if she chooses to go at all. After all, there is no shame in trade school, and apprenticeship, or on-the-job training.
But with that being said, we don’t want her saddled with debt after her education, assuming she makes wise choices.
And we would LOVE to have a nice sum of money set aside for her to do with as she wishes, whether pay for college, a wedding, a house, invest, or whatever else she feels is a wise decision.
However, not saving anything is not something that’s on our radar at all.
So no matter what level and type of savings you’re planing for your children, it is wise to explore all of the options and see which one fits your family best.
How and what are you planning to save for your child?
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