Parenting is one of the most rewarding experiences in life, but it is also one of the most expensive. From the moment you bring that bundle of joy home, you will be asked to fork over dollar after dollar to care for them. College is one of the largest expenses you will incur, and if you want to be able to afford it you need to start planning now. There are many ways you can save for college and the following methods are easy for you to begin saving for the education of your children.
1. 529 College Savings Plan
A 529 plan is a savings plan designed to encourage parents to begin saving for their child’s future college education costs. These plans are sponsored by the states and allow parents or other family members to contribute to these plans without being subject to many federal and state taxes. These plans usually have no minimum contribution amounts and can often be opened with as little as $25. As long as the beneficiary of the plan withdraws the money and uses it for education expenses such as tuition or books, the money can be withdrawn tax-free. If, however, it is used for other types of expenses, the beneficiary will be subject to both taxes and penalties as the money will then be counted as income.
There are two types of 529 plans: pre-paid tuition plans and college savings plans. The types of plans that are available will depend on the state in which you reside. The pre-paid tuition plans allow you to essentially pay tuition for colleges and universities in the state ahead of time. The college savings plan, on the other hand, is a more traditional investment account that allows you to contribute and grow your savings much like a Roth IRA.
2. Roth IRA
A Roth IRA is usually used as a retirement account that gives you extra income in retirement tax-free. In most cases, you are forced to pay a tax penalty if you withdraw the money before you are 59.5 years old, but the money can be withdrawn without a penalty if the money is to be used for education expenses.
While money you contribute to a Roth IRA isn’t tax deductible, as long as you meet the requirements when withdrawing the money you will pay no tax on the money you contributed or the interest you have earned. The Roth IRA often has much lower yearly contribution limits and often requires more money up front to open compared to the 529 plans, but they offer much more flexibility and freedom with the money, especially in the event that you child doesn’t go to college.
3. Coverdell Education Savings Accounts
The Coverdell Education Savings Account, also known as ESA, is another government-sponsored savings account for college. In practice it functions much like a traditional Roth IRA allowing you to deposit funds on behalf of your child that are not tax-deductible but remain tax-free when you withdraw them later for education expenses. These types of accounts often come with a contribution limit of $2,000 a year but any family member may contribute to the account. A beneficiary must be named for the account when it is created and these funds are specifically marked for education. Like 529 plans, you will pay a penalty if money is withdrawn for expenses other than education.
When saving for college, the earlier you begin saving, the better. This allows you more time to make contributions to the accounts and gives the money more time to earn interest each year so it can grow. It is never too late to start one, even if your child is already attending grade school. All of these options are a viable means of saving for your child’s education future. You must examine all of the rules and regulations involved with these different investment accounts and choose the one that fits your family and your financial status so you can reap the most benefits from these accounts.
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