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August 16, 2011 | | | Which Investments Are Best For College Savings? | | | The Tip:
College savings plans can limit how you use your money. Picking the right one can make a huge difference.
When it's time to start saving for college, you have several options. The best is an Education Savings Account (ESA) that turbocharges your college savings with tax-free growth and withdrawals as long as you spend the money on education.
Flexible, state-sponsored 529 plans also let you save and use your college savings tax free. These aren't as good as an ESA, but the 529 can still be a great choice in the right situation. Here are a few questions to ask as you decide which one is right for your family:
Q: How can I use the money?
A: Obviously, you're opening this account to pay for educational expenses, but each plan defines that differently. ESAs allow you to use the funds for private elementary, middle- or high-school tuition as well as post-secondary education. You can also pay for off-campus housing, computers and other education-related expenses with your ESA. But eligible expenses for a 529 plan are limited to college tuition, room and board, school-required books and supplies.
Q: How much can I invest?
A: If you plan to open your college fund with $2,000 or less, go with an ESA. You can contribute up to $2,000 per year per child into an ESA. If you want to save more, or if you make more than $200,000 per year, a 529 will come in handy. Unlike the ESA, the 529 has no annual contribution limit or income restrictions. You can also open both, using the first $2,000 to start the ESA (if you meet the income requirements) and putting the rest into the 529.
Q: How much control do I have?
A: Like a Roth IRA, you can invest in any mutual fund in any allocation you wish in your ESA—that's one big reason why an ESA is a better option than the 529 for most people. You can also change funds as often as you want. Most 529 plans are limited to one fund family and restrict the number of investment strategy changes you can make each year.
Q: What if my child doesn't go to college or gets a free-ride scholarship?
A: If the beneficiary of the ESA or 529 doesn't use the money by age 30, you can change beneficiaries at any time and as often as you want. Siblings, parents, nieces, nephews—pretty much anyone in the family is eligible. However, if you decide to use the money for non-educational expenses, you'll pay a 10% penalty plus income taxes on the distribution. There's some good news, though: If your child's expenses are covered by scholarships, and you withdraw money for non-qualified purchases, the 10% penalty does not apply!
Start Saving Today!
To get started on your kid's college fund, talk with a financial advisor who can help set up your ESA or 529. Dave's investing Endorsed Local Providers(ELPs) are experts who will help you decide which option is right for you and give you the same great investing advice Dave would. Contact your ELP today!
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