Popular options to save for your kids’ education

Growing your family can bring a lot of joy but can also mean many financial decisions and changes. There are additional considerations and decisions that parents need to make along the way, like who is changing the next diaper or who is cleaning up the food their little one just smeared on the living room wall. But after those short-term needs are handled, parents start thinking about their kids’ future.

One of the financial decisions parents should consider is whether they would like to help their children fund their education and how best to save money for that expense. Like most goals, there are a number of ways to accomplish this, and we’ve highlighted three of the more popular options for education funding below.

 

529 Plan

A 529 plan is a favorable option for saving for a child’s education, and for good reason, as there are many benefits. There are two types of 529s, and the information contained in this article will reference the more popular option which is the education savings plan. (The other we will not be referencing is the prepaid tuition 529.)

Essentially a 529 plan is an investment vehicle that offers unique tax benefits. The funds can be used for K-12 tuition (confirm taxation rules within your state), college education/tuition, certain college expenses, and student loan repayments. The 529 is funded with post-tax dollars, and when funds are withdrawn for approved expenses, they are neither taxed nor penalized. For this reason, this plan is most similar to a Roth IRA option but for education.

The 529 plan can be opened online in the state of your choosing. Once opened, the account owner will designate a beneficiary (typically the child) and start making deposits into the account. That money is then invested in the funds that the plan allows for, such as mutual funds or target date funds. Other family members can make contributions to the 529 plan as well, not just the account owner, which makes it a great tool for gifts to the child. Annual contribution amounts are limited to $15,000 per person, per year (the annual gift tax exclusion amount), but there are ways to “super-fund” the account with up to five years of annual gifts. Another benefit for Minnesota residents: You could receive a state tax credit or deduction for contributions made to a 529 plan.

There are quite a few nuances with 529s such as total allowable plan dollars available for annual tuition during K-12 education and restrictions on the amount that can be distributed for student loan repayments, among others. Please be sure to ask your JNBA Advisory Team or tax professional about these topics to ensure you will not run into any issues and that the plan is right for you and your family.

 

Taxable Brokerage Account

A second option for college funding is to open a taxable brokerage account. This option will give you the most control over your investments as you will have access to the widest variety of investment opportunities, whether they be ETFs, individual stocks, or bonds. Unlike 529 plans, money in the brokerage account can be accessed without penalty for any emergency or expense that may arise and is not limited to education expenses. There also is no limit regarding annual contributions to this account given you would be the account owner so it is technically not considered a gift.

The downside to a taxable account is that any income generated from the account such as dividends will be taxable in the year they are realized and reported on your tax return. Additionally, when you sell certain holdings you may be realizing capital gains which you would need to pay taxes on as well.

Using a taxable brokerage account compared to a 529 does provide flexibility in the fact that you do not have to use the money for education expenses and can use them for personal expenses as well. But there is additional taxation that you will have to realize each year.

 

UGMA

An UGMA is a type of custodial account that can be opened for minors under the Uniform Gift to Minors Act to be held for the benefit of children until they reach the age of majority, typically 18 in most states. In this account, the custodian can own a wide variety of investments such as savings accounts, stocks, EE bonds, or CDs.

As with the taxable brokerage account, the funds in an UGMA can be used for non-education purposes, giving it a bit more flexibility.

There are more downsides to this option though. One item you need to be aware of is that the “kiddie tax” will apply, meaning that any dollar over $2,200 of unearned investment income is taxed at the parents’ marginal tax rate. The money held in an UGMA does impact financial aid for the student because they are viewed as the student’s assets. A final consideration is that once the beneficiary reaches the age of majority, the account is legally theirs to take over.

 

Deciding how best to save for your child’s education expenses is just the first step. You then need to determine how much of their education expense you want to fund and what amount you should be saving each month or each year to achieve that goal. Please consult your JNBA Advisory Team to discuss what savings option is best for you and how much to save on an ongoing basis.

 

JNBA is not an accountant and no portion of the above should be construed as accounting advice. All accounting issues should be addressed with an accounting professional of your choosing.

Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.

Please see important disclosure information at www.jnba.com/disclosure

 

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