Financial Aid

Financial aid falls into two categories: need-based and merit-based.

Need-based financial aid

As you might expect, need-based financial aid is awarded to students based on their family’s financial need. The type and amount of aid you receive depends on your family’s level of income and assets, the cost of the school, and the ability of the school to meet your financial need.

Need-based aid can include Federal Pell Grants, subsidized student loans – meaning interest does not accrue until six months after the student leaves school, and the opportunity to participate in a work-study program.

You apply for this type of aid by filling out the Free Application for Federal Student Aid (FAFSA) and the College Scholarship Service Profile (CSS Profile).

Some families assume that they will not qualify for need-based aid, but it’s important to remember that the cost of the school plays a big role in the calculation, so the more expensive the school, the more likely you will qualify for aid.

It’s also important to understand how the Student Aid Index (SAI) is calculated – this is the amount you are expected to contribute to the cost of college.

In general, there are four categories of income and assets that factor into calculating the SAI: 

• Parent assets increase the SAI by up to 5.64% of the value of the assets.
• Student assets increase the SAI by 20%.
• Up to 47% of parents’ income is included in the calculation of the SAI.
• 50% of the student’s income is included, but there is an income protection allowance which is subtracted from the student’s income before the 50% is applied, so many students will not have any income factored into the calculation.

You can use this calculator to estimate your SAI.

Merit-based aid

Merit-based financial aid is typically awarded to students based on academic achievement or other factors, usually without regard to financial need. Encouraging your children to apply to schools where receiving merit aid is more likely can be a great way to reduce the cost of college. 

Strategies for Maximizing Financial Aid

Fill out the FAFSA and CSS Profile

You should fill out the FAFSA regardless of your income. Many colleges and universities require it for any form of financial aid, including merit aid and federal student loans. In addition, unsubsidized federal student loans are typically available to anyone who applies for aid. This could be a good way to access financing with favorable terms and no need for cosigners or credit checks.

It’s also critical to understand which schools require the College Scholarship Service (CSS) Profile. Many private schools use the CSS Profile in addition to the FAFSA to assess your financial need.

If your child is applying to a school that requires the CSS Profile, look into how that school calculates what aid you could be eligible for. Unlike the FAFSA, there is no standard formula used by CSS schools to calculate aid. They use what is called institutional methodology. For example, some schools include equity in your primary residence as an asset, while others do not.

The FAFSA and CSS Profile are made available on October 1st of each year (although the release of the 2023 FAFSA is delayed until December due to changes that are being finalized). And you should consider filling them out as early as possible, as some schools consider aid applicants on a first come, first served basis. 

Know which assets will count against you

Assets that are reportable on the FAFSA increase your SAI, reducing your eligibility for need-based financial aid. However, not all assets are reportable. And unlike income, which is counted based on the prior-prior year’s tax return, assets are reported as of the date the financial aid application is filed.

Assets that are factored into the SAI include bank accounts, investment accounts, equity in a non-primary residence or investment property, 529 savings accounts, small businesses, and custodial accounts.

Assets that are excluded from the SAI calculation are qualified retirement plans, such as 401(k)s and IRAs, qualified annuities, equity in your primary residence, and cash value of permanent life insurance policies.

There are several strategies that can be used to reduce your reportable assets for FAFSA purposes:

• Maximize contributions to qualified retirement plans as opposed to saving into taxable brokerage or savings accounts (but be careful to weigh your need for flexibility against the potential benefit of increasing financial aid, as taxable brokerage accounts provide the most flexibility). 
• Use reportable assets that are not needed to pay for college to pay down debt including auto loans and the mortgage on your primary residence. 
• Shift ownership of any assets owned by your child. If you have savings in a custodial (UGMA/UTMA) account that are earmarked for college, you could transfer those funds to a custodial 529 account, where they would be considered assets of the parents and receive more favorable treatment. 

You can use a net price calculator, where you enter information about your family to see what similar families paid at a specific school, to estimate the impact any of these strategies might have on your specific situation.

Remember that these strategies for limiting assets reported on the FAFSA may not be as effective if your child is applying to a school that uses the CSS Profile.

Reduce your income through tax planning

There are several tax planning strategies that can help reduce the income that is used both in the determination of eligibility for tax credits and the calculation of the SAI.

For higher-income families, education tax credits can be hard to come by. The American Opportunity Tax Credit and Lifetime Learning Credit are fully phased out once your modified adjusted gross income reaches $180,000 if you file a joint tax return.

But, if you have the ability to manage your income, doing so strategically can increase your chances of being eligible for these credits while also making you eligible for a larger amount of need-based financial aid. 

The tax year that will be considered on the first FAFSA that you file begins in January of a child’s sophomore year in high school. Beginning in that year, there are several strategies you could consider to manage your taxable income:

• Accelerate or delay the exercise of stock options.
• Strategically time deductible business expenses.
• Consider selling investments held in a taxable brokerage account before January of your child’s sophomore year if you plan to use these funds for college costs and anticipate recognizing significant capital gains.

Appeal decisions if you have changes in income

If your financial circumstances have changed from what was reported on the FAFSA or CSS Profile, you can consider appealing the school’s decision with the financial aid office.

If you had an unusually high income year because of a large bonus or equity compensation, you may be able to successfully appeal for additional need-based aid.

Alternatively, if you receive very different aid packages from what you believe to be comparable schools, you could bring this to the attention of the school that offered less aid. Some schools may make an adjustment, especially if they consider the school offering the better aid package to be a competitor.

Look for schools where merit aid is a possibility

Merit aid is not offered by all schools, so the first step is to understand which schools actually offer this type of aid, what percentage of students receive it, and what amount they typically give out.

You’ll then be more informed about your child’s chances of receiving merit-based aid. For example, if based on information provided by the school, you expect your child will be in the top 25% of students when it comes to test scores and GPA, there’s a good chance merit aid will be available if the school awards aid to the top 25% or more of incoming students.

Look for other types of merit scholarships

Many local and national organizations offer scholarships to high school seniors heading to college. Have your child talk with their school counselor to start putting together a list of scholarships that they may want to apply for.

College Saving Strategies

529 college savings plans are a great vehicle for tax efficient college savings. There is no income limit for taking advantage of the tax benefits offered, and recent changes have created additional flexibility, allowing you to roll unused 529 funds into a Roth IRA if you meet certain criteria.

Superfunding a 529 Plan

Superfunding a 529 plan is a strategy that can be used to maximize the tax advantages available. This allows you to contribute up to five times the annual gift tax exclusion in a single year without facing any gift tax consequences. 

Any investment growth within a 529 plan can be withdrawn tax-free if used for qualified education expenses. So the more time the funds have to grow, the more potential tax savings become available, which makes superfunding a powerful strategy.

State Tax Deductions

Another potential benefit of 529 plans is state tax deductions on contributions. This varies widely, so check the specific requirements of your state to see if this is something you can benefit from.

Grandparent-owned 529 plans

Recent changes to the FAFSA have opened up a new opportunity to reduce your reportable assets. The FAFSA no longer considers distributions from a grandparent-owned 529 plan as the student’s income for financial aid purposes. 

This means that funds used to pay for college from a grandparent-owned 529 (or a 529 owned by anyone other than the parents, for that matter) are excluded from both the parents’ assets and the student’s income when submitting the FAFSA.

Beware of Custodial Accounts

Saving in a custodial account (commonly referred to as an UTMA or UGMA) is less than ideal for financial aid purposes. These assets are treated as being owned by the child, which means that 20% of the balance is factored into calculating the SAI, as compared to parent-owned assets, which only reduce aid eligibility by up to 5.64% of the account balance. As mentioned above, you could transfer these funds to a custodial 529 account, where they would be considered parent assets. Alternatively, you could consider spending down the funds prior to filing the FAFSA.

When savings aren’t enough

When the net cost after need-based and merit aid is more than you have saved, first consider how much you can fund out of your current cash flow. Then weigh the cost/benefit of putting some of your other savings on hold and redirecting it toward college versus taking out private loans or parent PLUS loans to fund a portion of the costs.

Closing Thoughts

Navigating the financial side of the college landscape requires careful planning. Many opportunities exist for both need-based and merit-based assistance. And by filling out the necessary forms, researching scholarships, and maximizing tax planning and savings strategies, you can make college more affordable. Every family’s financial situation is unique, especially when it comes to planning for college, so if you’re looking to speak with a financial advisor, please reach out to us.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post How to Make College More Affordable appeared first on Still River Financial Planning.

This article will go into the detailed requirements of these new rules, which will take effect beginning in 2024, and discuss who can benefit most.

How it Works

While the new rules are intended to ease the concern many families have about overfunding a 529 plan, there are several limitations.

For starters, there is a $35,000 lifetime limit per beneficiary, although this may be indexed for inflation in future years. And the account must have been in existence for at least 15 years before transfers to a Roth IRA are allowed. 

In addition, any contributions or earnings on those contributions made in the previous 5 years cannot be transferred.

Who is Eligible

The funds in a 529 plan can only be transferred to a Roth IRA that is in the name of the plan’s beneficiary (typically the child or grandchild), not the owner of the plan. And this must be done as a trustee-to-trustee transfer, meaning you cannot take a distribution from a 529 plan then later make a contribution to a Roth IRA. The funds must move directly from one account to the other.

Transfers in a given year are limited to the lesser of the beneficiary’s earned income or the annual Roth IRA contribution limit ($6,500, or $7,500 if over age 50, for 2023). Keep in mind that the total contribution limit applies to all types of contributions, so for example if you had already contributed $2,000 to an IRA or Roth IRA this year, only $4,500 could be transferred from a 529 plan to a Roth IRA in the same year.

One significant benefit to the new rules is that there is no income limit, so even if the beneficiary’s modified adjusted gross income is more than allowed to be able to contribute directly to a Roth IRA, a transfer from a 529 plan can still be executed.

Who Can Benefit

Anyone who has over contributed to a 529 plan

In the past, if you had overcontributed to a 529 plan, you had a couple options. You could withdraw the money and pay taxes and a 10% penalty on the earnings, or you could change the beneficiary with the hope that another family member could use the funds for qualified education expenses.

The option to transfer funds in a 529 plan to a Roth IRA now allows for a way to preserve the tax-free growth of the money without being restricted by the requirement to use the funds for education costs.

One piece of the new rules that is yet to be clarified is whether or not changing the beneficiary restarts the 15 year clock for that particular account. If it does not, you could use up the $35,000 lifetime limit on the original beneficiary of the account, then change the beneficiary to another child or grandchild, or even yourself, and take advantage of additional transfers to a Roth IRA for the new beneficiary. Just be sure that you change the beneficiary to a qualifying family member. 

When changing beneficiaries, you should also be aware of gift tax implications – if the new beneficiary is of the same generation as the previous beneficiary, there are no gift tax consequences. But if the new beneficiary is one or more generations below the original beneficiary, the amount in the account is considered a taxable gift. In this case, you may want to avoid moving the entire $35,000 to a new beneficiary all at once and instead do this over time to stay under the annual gift tax exclusion ($17,000 for 2023).

Scholarship Recipients

Scholarship recipients can also benefit from the new rules. Previously, you could take penalty-free distributions from a 529 plan for the amount of scholarships received without having to use the funds for education expenses. However, you would still pay taxes on any earnings. Now instead of withdrawing the funds, a transfer to a Roth IRA allows you to avoid both taxes and penalties when you have excess funds because of a scholarship.

Parents Looking to Jumpstart Retirement Savings for Their Kids

A more unconventional approach to taking advantage of the new rules is to fund a child’s Roth IRA with money from a 529 as soon as they have earned income. If you open and fund a 529 plan when a child is born, the money will grow tax deferred, and after 15 years, you can make transfers to their Roth IRA if they have income from a part-time job. 

Alternatively, you could wait until after the child graduates from college and starts their first full time job. At this point, when they might not yet be making enough money to contribute on their own, you can fund their Roth IRA out of a 529 plan that has already been growing tax deferred.

In both scenarios, parents who have extra cash flow are able to take advantage of the tax free compounding much earlier on in the child’s life since they can make the 529 contributions before the child has any earned income.

People Who Are Phased Out of Making Roth Contributions

At a certain level of modified adjusted gross income, your ability to contribute directly to a Roth IRA is phased out. If you expect to be over this income threshold in the future, you could contribute to a 529 plan now, list yourself as the beneficiary, and in 15 years begin rollovers to a Roth IRA even though your income level limits your ability to contribute directly.

With this in mind, if you already have a 529 plan that has been open for 15 years or more, think twice before closing it down, even if there is only a small amount left in the account. Instead, you could make additional contributions now and start the 5 year waiting period to be able to begin moving those new contributions to a Roth IRA.

Who Might Not Benefit

Although the new rules can lessen some of the worry around contributing to a 529 plan for a beneficiary who may not end up using the money for college expenses, saving into a 529 may still not be the right move for everyone.

If you have significant doubts about whether your child will go to college, but want to put money aside for them to be able to use after high school but before retirement, you may want to choose a more flexible savings option. 

Closing Thoughts

For those with excess balances in a 529 plan today, the new rules provide a significant benefit. And they open up possibilities for new tax efficient long term savings strategies as well.

If you were on the fence about funding a 529 plan, you now have a strong incentive to open an account and at least fund it with the minimum contribution required by the plan. This will start the 15 year clock needed to be able to transfer any funds to a Roth IRA down the road.

However, be aware that there are some risks to taking advantage of the new rules over the long term. Congress or the IRS could thwart some of the planning strategies discussed by setting income limitations or establishing tighter rules around changing beneficiaries.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post Transfers to a Roth IRA: A New Feature for 529 Plans appeared first on Still River Financial Planning.

And if you’ve done some research and decided to open a 529 college savings plan, you probably know that the number of options available is overwhelming.

Most 529 plans are sponsored by states, but you don’t have to go with the plan that is sponsored by your home state.

Here’s how to consider the options available and choose the best savings plan for your family.

Direct-Sold vs. Advisor-Sold

There are two types of 529 plans, and some states offer one or the other, while some offer both.

Direct-sold plans can be opened by anyone, regardless of whether you work with a financial advisor.

Advisor-sold plans must be opened through a financial advisor. These plans are typically higher cost, and there may be sales commissions when you purchase investments within the plan.

Don’t let the names fool you, though – most advisors will still give you advice on your direct-sold 529 plan. For most families, this is the way to go.

Look for Tax Breaks

You probably know that money saved in a 529 plan grows tax-free if you use it for qualified education expenses.

But there are potentially more tax breaks depending on where you live.

Some states offer state tax deductions for contributions made to a 529 plan. So when deciding which plan to use, first take a look at your own state’s plan and see if there are tax benefits available.

This article is a great summary of state tax benefits.

Review Investment Options and Fees

Investment options and fees are two additional factors to consider when choosing a plan.

Look for plans that offer broadly diversified investment options. And do some research to find out how much you can expect to pay in fees on each of those investment options.

Savingforcollege.com provides a good quick reference which gives you a general idea of the fees charged by each state’s plan.

Many plans offer age-based portfolios, which can be a convenient way to save. These investment options become more conservative as your child becomes closer to college age. This means you don’t have to worry about adjusting your asset allocation manually over time.

Other Considerations

Custodial vs. Individual

If you are moving funds from a custodial bank or brokerage account (UTMA accounts fit into this category), you most likely need to open a custodial 529 plan.

This means that the child is the owner of the plan instead of the parent. The beneficiary cannot be changed, unlike in an individual plan, and the child gains full access to the money once they reach the age of majority in your state.

These limitations mean it usually makes the most sense to open an individual account if you are starting from scratch.

Flexibility

As with any savings goal, it’s important to balance tax savings and flexibility.

529 plans can be a fairly flexible option – the definition of qualified education expenses is pretty broad. And if your child receives a scholarship, you can withdraw funds up to the scholarship amount without penalties, although you will still pay income taxes on the gains.

If your child decides not to go to college, you can change the beneficiary, but if you decide to take the funds out for non-education related expenses, you’ll owe penalties and taxes.

So take some time to think about how much of the expected cost of college you want to save in a 529 plan vs. another more flexible savings vehicle like a brokerage account. As with most personal finance decisions, there is no perfect answer.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory meeting.

Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post <strong>How to Choose a 529 Plan</strong> appeared first on Still River Financial Planning.

This article will give some insight into how to think about choosing the best savings method based on your goals.

Clarify Your Goal

You first need to clarify what you’re actually saving for and trying to accomplish. 

Do you want to put money away for college so that your kids will graduate with minimal student loan debt? Do you want to save some money to give them a head start after moving out? Or maybe you want to help them get a jump on retirement savings.

Saving for College

Many parents first and foremost want to help their children get through college. And rightfully so – graduating with little or no student loan debt can be a huge benefit for a 22 year old still figuring out what they want to do.

If this is you, check out this guide to picking the best college savings account. 529 accounts have become the most popular and typically most advantageous savings vehicle for college. But if you want to save for one of the other goals mentioned above, keep reading to learn about your options.

Custodial Roth IRA

If your goal is to help your kids start putting money away for long term savings, a Roth IRA can be a great tool.

Tax Impact

Since the money grows completely tax free, the compounding benefits can be huge with such a long time horizon.

The downside is you can only contribute up to the amount of earned income the child has. But if they earn money from babysitting, mowing lawns, or any part time job, you can contribute to the Roth IRA for them up to the amount of income they earned. You could also consider matching their own contributions to encourage them to save some of the money they are making as well.

Because of the tax advantages of the Roth IRA, earnings within the account cannot be withdrawn (in most cases) until age 59 ½ without having to pay penalties.

Financial Aid Impact

When it comes to applying for financial aid, Roth IRAs have no impact as long as the child doesn’t withdraw anything from the account.

Legal Ownership

At age 18 or 21 (depending on your state), the child will take full ownership of the account. So it’s important to educate them about the potential penalties incurred from early withdrawals.

Outside of a college savings account, a Roth IRA is one of the most effective ways to save for children. There are not only tax and financial aid benefits, but also the ability to teach your children about saving and investing with a wide range of investment options available.

Custodial Brokerage Accounts

A custodial brokerage account may be the way to go if you want your child to have access to the savings before retirement, but don’t want to be pigeon holed into using the funds for college.

Tax Impact

Beware that investment earnings within this type of account are subject to the “Kiddie Tax”, which is in place to ensure parents can’t transfer a significant amount of investment income to their children to be taxed at a lower rate.

This means that for 2023 the first $1,250 of unearned income (this could be dividends, interest, or capital gains), is taxed at 0%. The second $1,250 is taxed at the child’s tax rate. And anything over $2,500 of unearned income is taxed at the parents’ tax rate.

Financial Aid Impact

Custodial brokerage accounts have unfavorable financial aid treatment. They are considered assets of the child, which means 20% of the account balance is included in the calculation of your expected family contribution.

Legal ownership

Similar to a Custodial Roth IRA, the child takes full ownership of the account when they reach the age of majority in your state.
However, the brokerage account allows for more flexibility since there are no rules around when the funds can be withdrawn or what they can be used for.

A Brokerage Account in Your Name

If the child having legal ownership of the account at 18 or 21 concerns you, open a brokerage account in your own name. 

Earmark the account to be given to your child at some point in the future. They can still have the benefit of learning about saving and investing and watching their money grow. 

You can then gift the account to them when you’re ready.

Tax Impact

Earnings in accounts in your name will always be taxed at your tax rate.

Financial Aid Impact

Accounts in the parents’ name do count against you for financial aid purposes. But only up to 5.64% of the account balance factors into the calculation of your expected family contribution.

Legal ownership

Since the account is in your name, your child would only have legal rights to the money once you change ownership of the account over to them. If it ends up being a significant amount of money, be sure to consider gift tax rules and filing requirements. In 2023, a couple can gift up to $34,000 each year to a child without any consequences.

Final Thoughts

There are several options when it comes to saving for your kids. Take some time to think about what your goals truly are for the money.  And finally consider the variables of taxes, financial aid, and legal ownership of each option before making your decision.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

Are you interested in staying up to date on new articles and other news from us? Sign up for our newsletter or follow us on Facebook and Instagram.

Ready to learn more about how we can work together? Schedule an introductory call.

Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post The Best Ways to Save for Your Children appeared first on Still River Financial Planning.

This article will get into the tax benefits, flexibility, and financial aid impact of a couple of the best options. But there are a few things you should consider before you start saving.

Make sure you’re saving enough for retirement and your other long term goals before you consider setting aside money for college.

You have options when it comes to paying for college – scholarships, financial aid, loans, etc. But there are no loans or scholarships to fund your retirement. So it’s critical that you focus on funding your own goals first.

Once you’re comfortable with what you’re saving for your long term goals, you need to consider how much you want to save for your children’s education. 

Some parents want to cover 100% of the cost. Others want their children to fund some of their own education while still helping to make sure they don’t graduate with a pile of debt.

There is no right answer, but it’s important to clarify what your goal is.

When you’ve decided that you have additional money to save and how much you want to set aside, it’s time to weigh the pros and cons of the saving and investment options available to you.

529 College Savings Plans

The Tax Benefits

529 plans provide the best tax benefits for college savings. The money grows tax free and can be withdrawn tax free if used for qualified education expenses. For example, if you invest $10,000 in a 529 plan and it grows to $15,000, you could withdraw the full $15,000 without any taxes on the earnings.

Some states also offer a state tax deduction as a savings incentive. When choosing a plan, first look at your own state’s plan if a deduction is available.

Another benefit of 529 plans is the 5 year gift tax averaging rule. This allows you to contribute five times the normal annual gift tax exemption in a single year. Typically, you can only contribute up to the annual exemption ($17,000 for 2023) before you begin reducing your lifetime gift tax exemption. 

This means that instead of contributing $17,000 for each of the next 5 years, you could make up to an $85,000 contribution this year with no tax consequences. This can be a huge benefit – the more time you give the savings to grow, the more you save on taxes when you make those tax free withdrawals.

Flexibility

If you don’t use the funds in a 529 plan for qualified education expenses, you will pay a 10% penalty and income taxes on the earnings. But there are a number of features that make a 529 plan a flexible choice for college savings:

The beneficiary of the plan can be changed at any time. There are rules about who the beneficiary can be changed to. But if you have one child who doesn’t end up going to college, you can make another one of your children (or even yourself) the new beneficiary.

There are no penalties if your child receives a scholarship. Funds can be withdrawn from the 529 plan up to the scholarship amount without paying penalties. You only pay taxes on the earnings.

The funds can be used for up to $10,000 per year per beneficiary of K-12 private school education costs. Although, the longer you leave the money in the plan, the more opportunity for tax free growth – so the accounts are best suited for college costs.

You can use a 529 plan to pay student loans. You can withdraw up to $10,000 tax and penalty free to pay down a student loan balance. The $10,000 limit is a lifetime limit per beneficiary.

Financial Aid Impact

529 plans are considered an asset of the parents if a parent is the owner of the plan. This means that only up to 5.64% of the account value is counted against your expected family contribution. This is much more favorable treatment than the 20% used for student owned assets.

The Bottom Line

The tax benefits and flexibility of 529 plans make them the best option for college savings if you are fairly certain your child will go to college. And if they don’t, you can always use the funds for a sibling or your future grandkids. Worst case, you can take the money out and pay the 10% penalty on the earnings.

Taxable Investment Accounts

The Tax Benefits

While there are no tax benefits specific to college savings, you will only pay capital gains taxes as opposed to (typically higher rate) ordinary income taxes on any earnings within these accounts. However, the real benefit in using a taxable investment account is the flexibility.

Flexibility

Savings in a taxable investment account can be used for any purpose. These accounts provide the ultimate flexibility. You don’t need to worry about changing beneficiaries or paying any penalties if your child doesn’t end up going to college.

You can also invest in just about anything you’d like within these accounts. This gives them a slight leg up on 529 plans which have limited investment options. Although the best 529 plans do have good low cost and well diversified options that are more than sufficient.

Financial Aid Impact

Taxable investment accounts are treated as an asset of the parents, similar to 529 plans.

You do need to be careful if your child has a custodial account, often referred to as an UGMA or UTMA account. These are considered the student’s assets which is less ideal from a financial aid standpoint.

If your child is receiving a cash gift from a family member to be used for college expenses, you’re likely better off putting it into a 529 plan instead of a custodial account if you anticipate receiving any financial aid.

If your child already has a custodial account, you can consider transferring those funds to a custodial 529 account where they will count as the parents assets and be less impactful to your financial aid award. Just beware of potential tax consequences because you need to sell the investments within the account before moving them over.

The Bottom Line

Taxable investment accounts are the best option if you are not sure that your child will go to college. They offer the most flexibility, despite missing out on some of the potential tax benefits of the 529.

Other Common College Savings Options

Roth IRA

You can use money from a Roth IRA to pay qualified education expenses and avoid the 10% early withdrawal penalty. But these accounts are much better suited for retirement savings. 

Earnings on withdrawals are still taxed if you withdraw the money before age 59 ½ so you are losing the number one benefit of putting the money into a Roth IRA to begin with. Using a Roth IRA should be more of a last resort option.

Coverdell ESA

Coverdell Education Savings Accounts used to be the best way to save tax efficiently for K-12 education costs. But these accounts have become less valuable now that you can save for pre-college costs in a 529 plan. 

There are also some significant restrictions to these accounts. There is a $2,000 annual contribution limit, you cannot change the beneficiary, and you can’t contribute at all if your income is too high. Overall, 529 plans have become a superior savings tool.

Savings Accounts

This is a safe place to store your savings, but cash in the bank will not keep up with inflation. And with the cost of college rising rapidly, you should look to other places to save for these expenses. Investing the money is the best way to ensure you’re not losing value in the long run.

Closing Thoughts

529 plans are the best option for most families looking to save for their children’s future college expenses. If you’re looking for more flexibility, a taxable investment account can be useful. 

Most importantly, make sure you are taking care of your own savings goals before putting money aside for college.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.

The post How to Pick A College Savings Account appeared first on Still River Financial Planning.