College Planning and Saving Options

Two words to describe college tuition: very expensive. That’s why it’s important to start saving for higher education as soon as possible.

The average tuition bill has more than doubled over the past 20 years, making it more important than ever to start saving for college early on. In 2021-22, the average cost of tuition and fees for a four-year degree ranged from $10,740 to $38,070 a year, according to the College Board. Unsurprisingly, private colleges are the most expensive, while public two-year programs are the most affordable.

Fortunately, financial institutions like KEMBA Financial Credit Union offer a number of savings vehicles to help you grow your college fund. Learn more about the available options and how to find which is right for you.

Coverdell Education Savings Accounts (ESAs) are flexible college savings plans named after Paul Coverdell, a U.S. senator from Georgia who championed the 1997 federal legislation that created them. With a Coverdell ESA, you can put your money into a variety of investment vehicles, like stocks, bonds, mutual funds, certificates of deposit and money market accounts.

While contributions aren’t tax-deductible, interest and dividends grow tax-free, and you won’t have to pay taxes on withdrawals used for qualifying educational expenses, such as tuition, room, board and books. Coverdell ESAs can also be used to pay tuition at private and parochial elementary schools and high schools, as well as colleges.

ESAs were designed for low- and moderate-income families, so there are financial guidelines around who can open them. 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.

529 plans, named for a section of the federal tax code, work 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 your child will enter college. As the date grows nearer, the fund’s investments grow more conservative. There are no income or contribution limits for 529 plans, but money can’t be used for primary or secondary school tuition.

529 plans are offered by individual state governments and administered by brokerage firms such as Vanguard and Fidelity, but you’re under no obligation to send your child to college in that particular state. It pays to seek out plans that charge the lowest brokerage fees. Some states, including Ohio, also give tax breaks to residents who invest in their home state’s 529 plan. Currently Ohioan’s can deduct up to $4K per year, per beneficiary.

The Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) are known as custodial accounts, which means parents oversee them on behalf of their children. These accounts can be opened at many banks, credit unions and brokerage firms, including KEMBA. They typically allow for a wide range of investment options, often barring only high-risk moves such as stock options.

One drawback is that 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.

The child gains control of the money upon turning 18 or 21, depending on his or her home state. In contrast, Coverdell accounts and 529 plans remain in the parent’s control throughout the college years.

While IRAs are primarily retirement vehicles, they also allow money to be used for education. Financial institutions like KEMBA 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.

Although you can avoid the early withdrawal penalty by using IRA money to cover tuition, this can have major income tax implications. It’s better from a tax perspective to withdraw money from a Roth IRA than a traditional IRA. It’s also smart to consult a tax advisor or accountant.

To learn about college savings strategies and how to choose the best option for you, contact KEMBA Financial Credit Union or visit one of our Ohio branches. Our representatives will gladly help you work out a strategy that best fits your financial resources and future needs.