Saving for your kid’s college can be harder than saving for your retirement. The clock starts ticking the day your child is born and as college draws closer, the less risk you can afford to take. Consider these tax-advantaged tools:
· Coverdell Education Savings Accounts (“ESAs”) let you save up to $2,000 per year per student. Earnings grow tax-deferred, and withdrawals are tax free for education costs tax prep
· Section 529 Plans are state-sponsored college savings plans. Each state sets its own lifetime contribution limit, which ranges between $100,000 and $300,000+. Traditional “prepaid tuition” plans cover specific units of tuition such as a credit hour or course. Newer “college savings” plans invest contributions in mutual funds for potentially higher growth, generally adjusting portfolios from stocks to bonds and cash as your child ages. You can choose any state’s plan; however, some states offer deductions for contributions to their own plans.
· U.S. Savings Bonds let you defer tax on gains until you redeem the bond. Interest on Series EE Savings Bonds issued after 1989 to individuals age 24 or above may be tax-free if you use it the year you redeem the bond for “qualified educational costs” (tuition and fees minus tax-free scholarships, qualified state tuition plan benefits, and costs for which you claim the American Opportunity or Lifetime Learning credit). For 2015, the exclusion phases out for households with “modified AGI” from $77,200-92,200 (singles and heads of households) or $115,750-145,750 (joint filers) and isn’t available for married couples filing separately.
Other Limits for ESA Plans and 529 Plans
Donor AGI Limit of $110,000 ($220,000 joint)
Contribution Limit $2,000 per year
Tax-free Withdrawals for elementary, secondary, and college costs, including reasonable room and board. Expenses paid out of ESA accounts do not qualify for American Opportunity or Lifetime Learning credits. Withdrawals not used for education are taxed as ordinary income.
Must use assets by age 30, otherwise pay tax on gains or roll into another family member’s ESA.
Contribution Limit of $115,000-315,000 lifetime
Tax-free for “qualified higher education expenses.” Withdrawals not used for college are taxable only if they exceed contributions.
You can designate new beneficiary if child chooses not to attend college.
Section 529 plans offer estate-tax breaks in addition to income-tax breaks: Contributions are considered complete gifts for gift tax purposes; you can contribute up to $14,000 per year per student, or $28,000 jointly with your spouse, with no gift tax effect; 5 year accumulation plan states that you can give a beneficiary up to $80,000 in a single year, or $160,000 jointly with your spouse, so long as you give no more for the next four years; plan assets aren’t included in your taxable estate unless you “front-load” contributions in a single year then die before the end of that period.
What’s more is if you lose money in a 529 plan, you can close your account and deduct the loss as a miscellaneous itemized deduction. You can also transfer accounts from one plan to another, but only once a year. If you’re saving for college and you own permanent life insurance, you can deposit savings dollars into your policy and take tax-free cash for college (or anything else for that matter). If you later surrender the policy, any gains exceeding your total premiums are taxed as ordinary income when you surrender the policy (hint you can still get all of your money out while not surrendering the policy).