College is expensive and the costs only seem to be going up.
The average cost of tuition, fees, room, and board for 2019-2020 was $30,500. If you’re the parent of a young child and you want to be able to help them afford post-secondary education, here are three tax-smart strategies you can use to save money each year.
Contribute to a Coverdell Education Savings Account
You can contribute up to $2,000 per year to the child’s Coverdell Education Savings Account (CESA). If you have several children, you can set up a CESA for each of them.
The contributions are non-deductible, but earnings accumulate free of any federal income tax. When the time comes you can take tax-free withdrawals to pay for your child’s post-secondary tuition, fees, books, supplies, and room and board.
Be aware that a Coverdell Education Savings Account may not be an option for you if your income is too high. Your ability to contribute to this kind of plan is phased out if your modified adjusted gross income is between $95,000 and $110,000 if you’re unmarried, or between $190,000 and $220,000 if you are a married joint filer.
Contribute to a Section 529 College Savings Plan
Section 529 College Savings Plans are a great way to invest money over several years for your child’s post-secondary education.
They are a state-sponsored arrangement that authorizes favorable treatment under the federal income and gift tax rules.
As the parent, you begin making contributions into a trust fund set up by the state plan that you choose. That money goes into an account for your college-bound child.
You can choose how and when you make contributions.
They can be either a lump-sum payment or they can be stretched out over several years via installment payments, it’s up to you.
The plan then invests the money under the investment direction you choose at the beginning.
Once your child reaches college age, you can take federal-income-tax-free withdrawals to pay eligible college expenses, including room and board under most plans.
Most plans will cover expenses at any accredited college or university in the county, not just the schools in the state that sponsored the plan. This also counts community colleges as well.
Basically, this kind of plan is a tax-advantaged way of saving for your child’s education and building up a college fund, making it a solid option for staying ahead of increasing education costs and inflation.
Don’t mix up Section 529 college savings plans with Section 529 prepaid college tuition plans. Just because they sound the same, that doesn’t mean they do the same thing.
The big distinction here is that the prepaid plan is a way of locking in the costs of tuition early on. Money deposited into a prepaid plan is guaranteed to match the inflation of costs to attend the designated school or schools, but that’s it.
The last thing to know about the 529 savings plans is that you don’t have to worry about the Kiddie Tax if they are set up in your child’s name. You’re making contributions with after-tax dollars so your child will be able to take the money out tax-free when the funds are used to pay for qualified higher education expenses.
Those are two simple ways you can save money for your child’s post-secondary education without losing money unnecessarily to higher taxes.
Which plans are you going to take advantage of?