Saving for the Costs of College – Understanding Your Options

Throughout our community this month, high school seniors will be graduating and many of them will be heading off to college.  With college costs increasing faster than the rate of inflation, saving to pay for these expenses is certainly on the minds of many people.

One of the most common questions parents ask is how they can begin saving for their child’s future education expenses. With the cost of higher education continuing to rise, many families are looking for ways to put money aside while taking advantage of potential tax benefits and investment growth.

The following questions and answers provide a basic overview of potential college savings options.

How can I save for college?

For many families, a 529 college savings plan is the most widely used option.  A 529 plan is a tax-advantaged account designed to help families save for education expenses. Contributions are made with after-tax dollars, but the funds grow tax-free, and withdrawals are generally tax-free if used for qualified education expenses.

These plans can be used for many colleges, universities, trade schools, and other eligible educational institutions.

Who controls the account?

Typically, the person who establishes the account remains in control of the funds.

For example, a parent may open an account for a child while retaining the ability to manage investments and determine when distributions are made. If the original beneficiary does not need the funds, the account owner may be able to change the beneficiary to another family member.

Are there different 

types of plans?

Yes.  Every state in the nation, except Wyoming, sponsors a 529 plan.  You can invest in whichever state plan you want, but if you are a New York resident and invest in the New York plan, you are eligible for an income tax deduction.

What is the tax deduction?

You can get an income tax deduction of up to $5,000 for a single taxpayer and up to $10,000 for married couples filing jointly.  These deductions apply only to your New York State income taxes, not federal income taxes.  They are not per child but rather in total per tax return.

What can I invest in?

The New York 529 plan is managed by the Vanguard Group.  There are two basic options for the plan.  The first choice is an age-based investment option and the second is to develop your own custom investment strategy using the funds available through the plan.  

Are there different 

age-based options?

Yes.  You can choose Conservative, Moderate, or Aggressive age-based options.  Often people will choose the Aggressive option when a child is younger and then move to Moderate or Conservative options, as the child becomes older.  You can generally change your investment choice up to twice a year.

What other options 

are there?

If you are looking for another option that allows you to save money for college expenses with tax-free growth and tax-free withdrawals, another option would be a Coverdell Education Savings Account (ESA).  

How is it different 

from a 529?

The Coverdell ESA allows more flexibility to the investor.  You can invest in individual stocks if you wish, as well as exchange traded funds (ETFs) or mutual funds.  ETFs and mutual funds are available through 529 plans, but you are limited to the selection available through the investment firm managing that particular plan.  

Are there downsides?

Yes.  With a Coverdell ESA, you can only contribute up to $2,000 per beneficiary per year.  They are also phased out at higher income levels.  For single filers the phase out starts around $95,000 and for married couples filing jointly it starts at around $190,000.

What is more popular?

529 plans are certainly more popular today than Coverdell ESAs.  It is estimated that nationally over $600 billion is invested in 529 plans.

Are there other options?

You can certainly save in other ways for college expenses, including investing in taxable accounts, Roth IRAs, or savings bonds.  Based on your personal financial situation, other types of investment may make sense.  For example, if you are unsure if a child will be able to use the funds for educational purposes, you may want to save money in your Roth IRA for them.  

How would that work?

Generally speaking, the money in your Roth IRA would grow tax free and be distributed tax free, just as with a 529 plan.  With a 529 plan, you can only withdraw money for qualified educational expenses, and you can change the beneficiary of the plan, but only to another family member.  With a Roth IRA, you can withdraw your funds for whatever purpose you wish.  Roth IRAs are, however, subject to income and contribution limits.  In addition, to the extent you are using your Roth IRA to save for a child’s education, those funds will not be available for your own retirement.  There are also some withdrawal restrictions with regard to Roth IRA earnings that you would want to discuss with a tax advisor.

The cost of higher education can seem overwhelming, but there are a number of tools available to help families prepare. Whether through a 529 plan, a Coverdell ESA, or another savings strategy, taking action today will help reduce financial stress in the future.

As with any financial planning decision, families should consider consulting with qualified legal, tax, and financial professionals to determine which approach is best suited to their individual needs and objectives.

Matthew J. Dorsey, Esq. is a shareholder with O’Connell and Aronowitz, 1 Court Street, Saratoga Springs, New York.  Over his twenty-nine years of practice, he has focused on the areas of elder law, estate planning, and estate administration.  Mr. Dorsey can be reached at (518) 584-5205, mdorsey@oalaw.com and www.oalaw.com.