College Savings Strategies

This video was created by Society of Grownups, which is a learning initiative of MassMutual.

Hi, I’m Rachel Rabinovich. I’m a Certified Financial Planner professional at Society of Grownups. Today I’d like to discuss saving for your child’s college education. As a planner, I’ve talked to many folks who are planning to have children, have just had a baby, or who have older children and want to know what they can do to help pay for their child’s education.

No matter how old your child is, it’s never too late, or too early to start saving. You’ve probably already decided that saving for college is an important goal. I know for me, helping my daughter pay for school was a top priority especially since it is so expensive and only getting more so. While I knew she’d have to take on some student loan debt, I wanted to ease the burden as much as I could. But it’s hard to know where to begin, so let’s talk about some tools to help you save in a way that makes sense for you.

Some types of college savings accounts offer tax benefits but also come with restrictions. One popular way to save is with a 529 plan. This allows you to invest money to pay for “qualified” college expenses where your earnings grow tax-free. So what’s a qualified expense? It’s any expense that is directly related to education like tuition, fees, room and board, or supplies. You will likely have to pay tax and a 10% penalty on any earnings you withdraw that are not used for qualified expenses. There are no restrictions on how much money you make but there are limits on how much you can contribute. One of the cool things about 529 plans is that if your child doesn’t need the money, you can transfer the benefit to another family member who is planning to go to college.

Coverdell savings plans, also known as ESAs, have more restrictions. They allow you to save up to $2,000 a year per child under age 18 and there are income limits. Also, the money needs to be used by the time your child is 30. Your investment earnings are tax-free if used for qualified expenses and will cover K through 12 in addition to college costs. Like a 529 plan, you can transfer the benefit to another family member, but unlike a 529 plan, they must be under the age of 30.

Roth IRAs are not just for retirement! They can also be used to fund education as well. Any money you contribute to a Roth can always be withdrawn without paying tax or the 10% penalty. If you have had the account for 5 years, and are under 59½, you can withdraw the earnings for qualified educational expenses without the penalty but you will still have to pay taxes on them. There are a bunch of restrictions, so check out the IRS website for all the guidelines.

Finally, you can buy qualifying U.S. Savings Bonds, called Series EE or I Bonds, to cover tuition and fees only. Your contributions are made with after-tax dollars, but the interest may be tax-free if you use the bonds to pay for these qualified costs. There are income limits for tax-free interest status.

Check out the IRS website for current contribution and income limits on any of these tax-advantaged types of accounts since the rules can change from year to year. There are other savings tools that don’t offer tax benefits but which still could be useful to you. Have you ever heard of an UTMA or an UGMA? These are investment or savings accounts that you open for your child’s benefit. There are no restrictions on how much you can contribute and they are not tax deferred. But there are some special tax rules so it’s a good idea to check with a tax specialist first. Be aware that the money legally becomes your child’s at the age of majority (so check your state’s laws). All of this means that the money doesn’t have to be used for education and your child can spend it any way they want (even on a trip to Aruba). It can also have a greater impact on your child’s financial aid eligibility than most other accounts, and not in a good way. It could mean a little less financial aid in the form of scholarships or loans.

Finally, you can save for your child’s education with a standard savings or investment account. Even though there are no tax benefits, there are also no restrictions on your income or how much you can contribute. So if your child doesn’t go to college, you can use the money for anything you want! There are plenty of questions to ask yourself when considering your child’s financial future. And as you can see, there is no “one size fits all” answer to how to save for your child’s education. It comes down to what is going to work best for your situation, whether that is maximizing your savings with tax benefits or having greater flexibility with your money.

Thanks for watching today. 

The information provided in this video is not written or intended as specific tax or legal advice. MassMutual, its employees and advisors are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Not all MassMutual advisors are financial planners.