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3 Tax-Advantaged Ways to Save for College

01.23.20
By: American Heritage

You want your child to enjoy the best opportunities, in their future career and throughout life. Supporting their higher education is one of the best ways to help make this happen.

After all, it’s no secret that people who hold college degrees have a better chance of landing higher-paying jobs and earning more over their lifetime. Yet college costs are soaring: Over the last 40 years, the price of tuition and fees has increased by more than 1,100%. Not even healthcare costs have increased that quickly.   

Unfortunately, very few students earn enough in scholarships to cover their full education. While student loans are important, you don’t want your future college grad shouldering too much debt and struggling to make ends meet years after they’ve graduated.

 

TAX BENEFITS FOR EDUCATION

The best way to make college affordable is to start saving as soon as possible. And the best way to build your college fund is with a tax-advantaged account or savings plan, which can help you grow your savings faster and keep more money available for what’s important: your child’s education. Here are three popular savings options that offer tax benefits: 

 

1. 529 Plans

Named for IRS Section 529, the PA 529 – one of many such plans offered by states across the country – gives families a way to save and invest for college while taking advantage of tax benefits when qualifications are met. It can be used for:

  • Qualified education expenses (including tuition and fees, room and board, books, and supplies) at colleges, universities, and career schools
  • Tuition expenses (up to $10,000 per year) at public, private, and religious elementary or secondary schools

With a 529, your savings grow tax-free, and once you’re paying for school, money in the account can be withdrawn tax-free when used for qualifying expenses. Here in Pennsylvania, you have two different options:

 

Investment Plan

With a PA 529 Investment Plan (IP), families can choose from a list of 17 investment options ranging from conservative to aggressive. How fast your savings grow will depend on the performance of the assets your fund invests in.

 

Guaranteed Savings Plan

The cost of tuition is rising fast. The PA 529 Guaranteed Savings Plan (GSP) can help protect against these rising costs by “locking in” your student’s tuition cost at today’s rate for many different state, private, and community colleges. So, if the in-state tuition for a semester at Penn State costs $9,000 in 2019, the GSP plan could let you pay that amount in 10 years, regardless of how much tuition rises between now and your student’s freshman year.

Regardless of which 529 plan you choose, anyone – including grandparents and other family members and friends – can contribute. But be aware that single-year contributions over $15,000 may be subject to a gift tax. 

Don’t live in Pennsylvania? New Jersey, Delaware, and many other states offer their own 529 plans. Note that certain program details vary from state to state.

 

2. Coverdell Educational Savings Account

A Coverdell ESA works basically like a 529 plan, but education savings account rules and requirements are different from those of 529s:

  • Your contributions are not tax-deductible (unlike for 529s, which may be deductible on your state taxes)
  • There are income limitations
  • The maximum annual contribution is $2,000, far less than you could add to a 529

Like the 529 plans, a Coverdell ESA offers tax-free investment growth and withdrawals to pay for qualified education expenses. These accounts cover not just elementary and secondary tuition but also books, supplies, academic tutoring, and even special needs services for eligible schools.

 

3. Roth IRA

A Roth IRA is technically a retirement plan, not a college savings account, but it could still be a valuable option for your family. If you are eligible for a Roth IRA, it’s a great way to invest after-tax income and enjoy tax-deferred earnings as you build your nest egg. A Roth IRA lets you make early, penalty-free distributions to pay for qualified education expenses for your child.  

While a Roth IRA has more restrictions than a 529 plan – there are lower annual contribution limits and income limitations – it offers greater flexibility as well. This plan allows far more investment options than a 529 investment plan, and you can ensure that every dollar is put to good use, paying either for your student’s education or your own retirement.

This flexibility is nice, but remember that the money you spend on college costs is money you won’t have for retirement. Make sure that supporting your child’s higher education doesn’t come at the expense of your own financial security in retirement.

 

START SAVING TODAY

We get it. Saving and paying for college can get complicated. There are many options to consider and details to track. Our knowledgeable team at the American Heritage Investment & Retirement Center is ready to discuss your education planning needs and help you choose what’s right for you, your student, and your finances. Reach out today to get started.