Funding your child's college education
It's never too early to start saving for a child's future college education. When you give yourself a head start, your money will have more time to grow and more time to weather the market's ups and downs.
Both the federal and state governments have made it much easier to save for college. There are tax-favored choices that can help put a college education within reach.
Savings Options
Compare the key characteristics of four popular investment alternatives for education investing:
Coverdell Education Savings Account
Contribution Limits
Up to $2,000 per child (under age 18) for contributors with modified adjusted gross income of $190,000 if filing jointly or $95,000 for single filers. The maximum is reduced and gradually phased out for those with modified adjusted gross income between $190,000 and $220,000 (joint filers) or between $95,000 and $110,000 (single filers). Those who exceed these income limits are not eligible to make contributions.
Tax Treatment
- Tax-deferred growth
- Earnings are tax-free if used for eligible education expenses, which include room and board, tuition, books, supplies and equipment, academic tutoring, and special needs services.
Control of Assets
Responsible individual (generally a parent or guardian)
Restrictions
- To avoid penalty, must be used for eligible education expenses
- Must use funds by the time the beneficiary reaches age 30
Pros
- Account can be transferred to another relative of the beneficiary
- Adults other than parent can make contributions
- Can be used for elementary, secondary and higher education
Cons
- Not available to high-income families
- Low contribution limit
- Penalty for withdrawals not used to pay eligible education expenses
Note: One important feature of these tax benefits is the "sunset" provision which sets a limited time for the changes to apply. All new provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 expire after December 31, 2010. On January 1, 2011, all tax provisions in effect prior to signing of the Act will be reinstated if future legislation is not passed ($500 annual limit).
Custodial Account (UGMA/UTMA)
Contribution Limits
None
Tax Treatment
In 2008, the first $900 of a child's investment income is tax free and the next $900 is taxed at his or her own rate. But any unearned income in excess of $1,800 in 2008 is taxed at the parents' presumably higher tax rate.
Starting in 2008, the kiddie tax will be expanded to include dependents under 19 and dependent full-time students under 24. Children who provide more than half of their own support are not affected by this kiddie-tax change.
Control of Assets
Custodian (until the child reaches age prescribed under applicable UGMA or UTMA)
Restrictions
- Must be used for benefit of child.
Pros
- No contribution limits based on family income.
- Adults other than parent can make contributions.
Cons
- No tax-advantaged growth
- Contributions are not deductible
- Child gains control of assets at age prescribed under applicable UGMA or UTMA
529 Prepaid Tuition Plans
Contribution Limits
Depends on plan rules, but typically ranges from $15,000 to $30,000
Tax Treatment
- Tax-deferred growth
- Withdrawals are federal income tax-free if used for qualified higher education expenses
Control of Assets
Adult in whose name the account is registered (account owner)
Restrictions
- Usually must attend school in state that sponsors the plan
- Must be used to pay for qualified higher education expenses
Pros
- No contribution limits based on family income
- Adults other than parent can make contributions
Cons
- Penalty on withdrawals that don't qualify as higher education expense
- Plans frequently offer low rate of return
- Use of funds may be limited to in-state schools or particular institution
529 College Savings Plans
Contribution Limits
Depends on plan, but contribution limit is typically based on estimated cost of colleges in a particular state or region for 4 years (and in some cases, an additional 2 years)
Tax Treatment
- Earnings are free from federal (and possibly state) income taxes
- Withdrawals are federal income tax-free if used for qualified higher education expenses
- Potential gift tax and estate tax savings
- The availability of such tax or other benefits may be conditioned on meeting certain requirements.
Control of Assets
Adult in whose name the account is registered. The account is registered for the benefit of the student (designated beneficiary), but the control remains with either the donor or the account owner.
Restrictions
Must be used to pay for qualified higher education expenses in order to avoid penalty
Pros
- Contribution limits are based on cost of higher education rather than family income
- Adults other than parent can make contributions
- May be used at any eligible higher-education institution in the U.S. and some abroad
Cons
- Penalty on withdrawals that don't qualify as higher education expense
- Limited flexibility once money is invested (can change investment strategy once per calendar year)
State Farm VP Management Corp Risk/Important Disclosures. State Farm Mutual Funds Prospectus. The State Farm College Savings Plan Enrollment Handbook
(PDF 445 KB)
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AP2009/03/2456 |
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