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College Planning and Savings Options
A good college savings plan is a requirement in this course.
Here's how to put one together.
Higher education requires higher savings goals
Here are two words to describe college tuition: Incredibly high. Here’s one word that describes when you should start saving for your child’s education: Yesterday.
The average tuition bill has catapulted by 260% since 1980. According to the College Board, the average cost of tuition and fees for the 2022–23 school year was $39,400 at private colleges, $10,750 for state residents at public colleges, and $27,620 for out-of-state residents attending public schools.
College officials and politicians have talked about reining in tuition. So far, that’s all it is – talk. That’s why you should act to save enough to maximize your child’s higher education options. The good news is you have 18 years or so pull together this large sum of money, and you have a variety of saving options.
Several of these investment vehicles can be found at Paducah Bank. Our representatives in Paducah and Louisville, Kentucky, will gladly help you work out a strategy that best fits your financial resources and future needs.
About that name: No, Coverdell wasn’t a famous educator. Paul Coverdell was a U.S. senator from Georgia who championed the federal legislation that created these accounts in 1997.
Nuts and bolts: Coverdell ESAs are flexible college savings plans that you can open at Paducah Bank. You can put your money in pretty much any investment vehicle, ranging from stocks, bonds and mutual funds to CDs and Money Markets. Contributions aren’t tax-deductible, but interest and dividends grow tax-free and no taxes are paid on withdrawals used for qualified educational expenses, such as tuition, room, board and books.
Consider this: Coverdell ESAs can be used to pay tuition at private and parochial elementary schools and high schools, as well as colleges.
Final thoughts: ESAs were designed for low- and moderate-income families, so there are financial guidelines on who can open one. Also, total contributions are limited to $2,000 per student per year, or $36,000 total. That means there’s a good chance you’ll need another savings vehicle to cover rising tuition costs.
About that name: The number refers to a section of the federal tax code. Don’t be put off by the wonky name. The investment accounts are easy to open and involve no contact with the Internal Revenue Service.
Nuts and bolts: 529 plans operate much like Coverdell ESAs. You invest post-tax money; it grows tax-free and you pay no taxes when it comes time to cover college expenses. One difference is the investment options. 529 investors are generally limited to a pool of mutual funds, many of which align with the date when the child will enter college. As the date grows nearer, the fund’s investments grow more conservative.
Consider this: There are no income or contribution limits for 529 plans, but money can’t be used for primary or secondary school tuition.
Final thoughts: 529 plans are technically offered by individual state governments and administered by brokerage firms. You’re under no obligation to send your child to college in the state whose 529 you use. It pays to seek out plans that charge the lowest brokerage fees. Also, some states give tax breaks to residents who invest in their home state’s 529 plan.
About the names: UMGA and UMTA may sound like bad guys in a Star Wars movie. But the Uniform Gift to Minors Act and Uniform Transfer to Minors Act are positive forces in the college saving universe.
Nuts and bolts: These are called custodial accounts. That means parents oversee them on behalf of their children. The accounts can be opened at many banks, credit unions and brokerage firms. They typically allow a wide range of investment options, often barring only high-risk moves such as buying stock options.
Consider this: One drawback is a portion of the investment income may be taxed each year as “unearned income.” On the plus side, if a child opts not to go to college, or the money is needed sooner for other reasons (such as medical expenses), money can be used for non-educational purposes with no tax penalties.
Final thoughts: The child gains control of the money when they turn 18 or 21, depending on their home state. That means they can opt against college and use the money to buy a motorcycle or travel to Europe. In contrast, Coverdell accounts and 529 Plans remain in the parent’s control throughout the college years.
About the name: Wait, aren’t IRAs how people save money for their golden years? Yes, that’s true. But IRAs also allow money to be used for education purposes.
Nuts and bolts: Paducah Bank and other financial institutions offer two types of IRAs, Roth and Traditional. Generally, withdrawals made before the investor reaches 59½ years old are subject to 10% early distribution penalties. But there are exceptions for higher-education funding or buying a first home. With a nearly unlimited range of investment options, an IRA can be an effective way to grow money for college costs.
Final thought: Although you can avoid the early withdrawal penalty, using IRA money to cover tuition can have major income tax implications. It’s better from a tax perspective to draw money from a Roth IRA than a Traditional IRA. It’s also a good idea to consult a tax advisor or an accountant to learn about the tax impact of all types of college savings strategies.
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