Best Way to Save for College
I was about twelve when my father purchased a used pickup truck for the purpose of “helping you boys go to college”. I was greatly disappointed that he chose a green truck instead of the multi-colored striped one that I had my heart set on. My oldest brother had some experience working for another family with a large lawn business and convinced my dad that he could make some money if only he had a truck. That pickup became the means for the Johnson brothers to put three boys through a combined twenty years of undergraduate and graduate degrees of college (combined 3 undergraduate and 3 graduate degrees).
As I look back on my experiences as a youth running a small business and mowing lawns almost every warm/dry day for six plus years there were some life lessons which were perhaps more important than the money. I’d encourage every parent who reads this to consider the positive impact that kid’s having “skin in the game” has on their appreciation for the college opportunity and determination to succeed.
While I put the money I earned into CD’s and savings accounts – there are better tools now to collect the proceeds of kid’s earnings as well as parental/grandparent contributions. Here’s some thoughts on how you can best navigate the financial aspect of savings given various available options:
Pros: You will get great flexibility on both investment options and use of these accounts. No limit on how much you can invest.
Cons: Capital Gains on withdrawals (as high at 20% for high income families). Assets in student name will reduce financial aid eligibility by up to 20% (5.64% if owned by parents).
Custodial Accounts (UGMA/UTMA)
Pros: Money saved can be spent on anything including cars, flights, computers as long as its for the benefit of the minor. No limit on how much can be invested.
Cons: Assets will be students at legal age to be used at their discretion. More complex taxes and assets are considered student’s and can reduce aid by 20% of the account value.
Coverdell Education Savings
Pros: Tax-free withdrawals to pay for college and K-12 expenses. Flexibility to choose investments. Account is considered a “parent asset” on FAFSA application for student aid.
Cons: Max of 2k contribution per beneficiary per year. Parents must have income below 200k (95k for single filers) to be eligible to contribute.
Pros: Funds grow tax free and can always be taken out to pay for qualified college expenses without incurring a 10% penalty.
Cons: Must have earned income to contribute to a Roth. Withdrawals to pay for college are considered as income on the FAFSA application.
Pros: Funds grow tax free and qualified college or K-12 withdraws avoid federal tax. Large contribution allowed. Favorable financial aid tax treatment (parental assets) and no need to report income to FAFSA aid application. Utah’s plan (my529.org) also gets a state tax credit for contributions.
Cons: Funds must be spent on educational expenses or get 10% penalty.
Summary: Clearly 529 plans are superior for the vast majority of family situations. They provide flexibility, tax deferral and when contributing to Utah’s plan as a Utah resident a tax credit. It just so happens that Utah’s plan is probably the best 529 plan in the country! Parents who want to get the ball rolling for their children can open an account for each child and make monthly contributions through Utah’s fabulous low cost plan. You can start as soon as your child is born and the funds can help pay for K-12, college and graduate degrees as well as technical school programs if your kids go that direction instead of college.