May 29^th is celebrated in the US as 529 College Savings day: a day to highlight the importance of saving for post-secondary education.

In the 529 day spirit, I’m going to dedicate this month’s Wealth Management 101 to college savings.

In my practice, saving for college is a common goal and I find that many parents and grandparents just aren’t sure where to start.

With tuition costs continuing to rise faster than inflation, and the benefits of post-secondary education being clear^[1], saving for higher education may be key to securing your child’s future.

This month, I’ll walk you through the various vehicles available and the pros and cons of each.

What I won’t address is how much to save.

That’s a different animal, and you can find information on setting savings goals elsewhere on my blog.

1. Savings or Investing Account

Saving for college does not have to be done using an education-specific account. You can simply put money into a savings account or investing account.

By doing so, you’ll make sure that you can use those funds for any purpose and at any time.

This may be important if you don’t have the resources to dedicate dollars to a specific goal in an account with strings attached.

However, you give up potential tax benefits and may miss out on some other benefits.

2. Series I Savings Bonds

An often overlooked option for college savings are US Savings Bonds. Series I bonds can be used as a tax advantaged vehicle for college savings. Saving Bonds are purchased directly from the US Government through Treasury Direct.

Here’S how it works: A qualified owner of Series I bonds may exclude the interest income from Series I bonds cashed in during a given year, from their taxable income for that year, if they also paid qualified education expenses in that same year. I bonds may earn interest for up to 30 years or until they are cashed; making them a potentially attractive long-term savings vehicle.

There are some limitations and requirements to be aware of.

An individual may only purchase up to $10,000 of Series I bonds each year so your investment in this instrument is capped annually. Further you must meet these criteria to exclude the interest income on Series I bonds that you cash to cover education expenses.

• The bonds cashed must have been issued after 1989 and be in the name of the individual cashing them and claiming the income exclusion.
• The bonds must be cashed in the same year that you are claiming the exclusion of the interest income.
• You must have paid qualified education expenses for yourself, your spouse, or dependents in the year you cashed the bond and are claiming the exclusion.
• Your tax filing status can’t be Married Filing Separately.
• Your Modified Adjusted Gross Income must be under $111,800 if you are single, head of household, or a qualifying surviving spouse or under $175,200 if you are married.
• You were already age 24 when the bonds you cashed were issued.

Series I Bond may be most appropriate for lower income, conservative savers.

You can find more information about Series I bonds at www.treasurydirect.gov.

3. UGMA/UTMA

UGMA stands for Uniform Gift to Minors Act, and UTMA stands for Uniform Transfer to Minors Act.

Both refer to the legislation of the same name that created the UGMA/UTMA account type.

For simplicity’s sake, I’ll refer to these as UTMAs for the remainder of this article.

A UTMA has two parties: the trustee (usually a parent) and the beneficiary (the minor child).

Minors are barred from directly owning property, and thus financial assets must be held in trust until they reach the age of majority.^[2]

“In general, a UTMA can be funded by anyone, and the trustee controls the assets until the minor reaches majority.”

UTMAs are subject to the kiddie tax, where taxes may be due if unearned income in the account totals more than $2,700 in a given tax year.^[3]

Also, control of the account must be turned over to the minor when they attain the age of majority.

These two elements make a UTMA less-than-ideal for college savings.

These accounts are much better for outright gifts.

UTMAs for Young Investors

4. Coverdell ESA

A Coverdell Education Savings Account is another option.

However, with college costs rather robust, this account may not get you where you need to be.

Like a UTMA, there are two parties to this account type: the custodian (or trustee, usually the parent) and beneficiary (the child).

The assets are considered the property of the custodian and subject to their sole control regardless of the age of the beneficiary.

The single biggest advantage Coverdell ESAs have over Section 529 Plans (discussed later) is the ability to choose nearly any investment you wish to own.

That might include mutual funds, exchange-traded funds, individual bonds, and/or individual stocks.

The investments grow tax-free and remain tax-free if they are used for qualified education expenses.^[4]

These accounts can also be rolled into a Section 529 Plan if that suits the goals of the parties.

Now the downsides.

“A Coverdell is limited to contributions of only $2,000 per beneficiary per year, meaning you may not be able to save enough to cover all college expenses.”

Further, high income earners^[5] are barred from contributing to these accounts.

Finally, if the funds are not used by the time the beneficiary turns 30, the account must be distributed to the beneficiary.

The Coverdell ESA is a good option for grandparents who want to lay aside funds for higher education but are also comfortable gifting those funds later in life if their grandchild does not use the money for post-secondary education. There is a higher likelihood that a grandparent can meet the income requirements and that they will not need to over all of a child’s education expenses.

5. Section 529 Plan

The most well-known and popular option for college savings is the Section 529 Plan, often just called a 529.

These plans were created by Section 529 of the Internal Revenue Code.

Unlike UTMAs or Coverdells, 529 plans are administered by each state, instead of being set up by an individual.

Like the other two account types discussed above, there are two parties: the participant (usually the parent) and the beneficiary (the child).

The assets are considered the property of the child but are subject to the control of the participant.

“All growth is free of federal taxes as long as funds are used for qualified education expenses.”

In addition, if you live in a state where there is state income tax, your 529 plan contributions may be deductible from your state income taxes.

One of the biggest advantages of the 529 is that there are very high limits on annual contributions^[6] and no limits on the income of the donor.

Anyone can put money into the plan, making it ideal for gifts from grandparents, other family members, and friends.

That means a family could choose to frontload their savings in early years to take advantage of long-term compounding or use the account as a lifetime gifting or asset transfer tool.

Another great feature is that there is no age limit on beneficiaries.

“Unlike with a Coverdell or UTMA, there is no deadline to distribute funds or turn the account over to the beneficiary’s control.”

Finally, recent tax law changes now allow for balances in 529s to be rolled over into a Roth IRA in the name of the 529 beneficiary. While this is a welcome change, there are strings attached.

Be sure to consult your Financial Advisor and tax expert before planning or undertaking a rollover strategy.

A drawback of 529s is that investing choices are limited.

Each plan has a menu of options to choose from, much like your 401(k).

Another disadvantage is that each plan will differ based on the state that administers it, meaning you’ll have to do quite a bit of research to know which plan works best for your situation.

Fortunately, there are websites like SavingForCollege.com that aggregate information and offers free calculators and comparison tools.

There is no silver bullet solution that will meet all your post-secondary needs and goals. Most clients use a combination of account types.

A good Financial Advisor will take the time to understand what you want to achieve and what resources you have available, and then help you pick the right mix of accounts to suite your specific needs.

Want to learn more about saving for college?

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