Financial Planning: How To Pay For College Through Investment

Coverdell Education Savings Accounts and 529 Plans can be useful tools in saving for higher education costs.

College costs are significant regardless of the family's financial situation. From poor to wealthy, the expense can be unsettling, and the best way to prepare for this expenditure is through proper planning and investing.

There are two primary types of accounts that are specifically set up to handle education savings: Coverdell Education Savings Accounts and 529 Plans. A Coverdell account, formerly titled an Education IRA, allows for $2,000 per year to be contributed towards the growth of the account. The earnings on the contributions are tax free and withdrawals for educational expenses are free from federal tax. At the age of majority, the beneficiary (typically the child) assumes control of the account, and may use the assets to cover not only tuition but room and board, book and supplies. It is important to note that the ability to contribute to a Coverdell account is phased out depending on the adjusted gross income (AGI) of the parent or parents. Currently, phase out for married couples occurs when AGI is between $190,000 and $220,000, and phase out for individuals occurs when AGI is between $95,000 and $110,000.

A 529 Plan is structured similarly to a Coverdell Education Savings Account in that again, earnings grow tax free and withdrawals for education expenses are free from federal tax. However, 529 plans have a few benefits over Coverdell Accounts. First, a typical 529 plan does not cap the annual contribution limit to $2000, although it may cap the total amount that can be saved through the plan. For instance, the College America plan caps the contribution to $250,000. Also, 529 plans do not have a phase out for AGI, so regardless of income level parents can contribute to their child's accounts. In a 529 plan, the beneficiary does not gain control of the assets when majority age is reached. Rather, the owner retains control, and the beneficiary can be changed if the original beneficiary decides not to attend college or assets remain after he or she has completed a degree. There are a number of 529 plans to choose from, and depending on the specific plan, they work in one of two ways: the 529 plan can act as a savings account for a specific school or as a general savings account to be used at any institution. It is important to invest in a 529 plan that allows for the greater flexibility; if your plan is specific to your local college and your child never attends, the school often keeps the assets. As 529 plans are sponsored by states, contributing to an in-state plan may be tax deductible.

Both Coverdell Accounts and 529 Plans are specific to education costs. Funds can be used to cover trade school costs as well as graduate school costs. However, if money is withdrawn and used for a purpose other than education, ordinary income taxes as well as a 10% federal tax penalty will apply on earnings.

One additional way to provide for a child's education through investments is for parents to begin investing in the market. Unlike an education-specific plan, dividends and interest earned would be taxable, but use of the assets would not be regulated to education. In the case that your child decides not to pursue higher education, the money in the account would be available for you to use at your discretion.

Regardless of how you decide to save, the key is to start early. Costs are rising at a fantastic rate, if you plan to assist a child through a program of higher education, seek out financial planning advice from someone you trust and start a plan that is right for you.

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