While there are many ways you can save for college, these various strategies are not equal. You get some particular tax advantages with the best savings channel, provided you use the funds for college. It is essential to prioritize tax-advantaged strategies since you will accumulate a lot of money with time.
Overall, your choice should be a savings channel that gives you a terrific combination of flexibility, financial benefits, tax advantages while making your investment goal possible. Here are some ways to save for college:
Custodial Accounts
With a custodial account, your kid can hold assets that a chosen custodian will guide. Such investments can help pay for college or whatever benefits the kid, like piano lessons, summer camps, etc. Here is the breakdown of how it works:
You completed an application at a financial institution and chose your beneficiary.
Also, you will choose a custodian who will manage and invest such assets
You and anybody can contribute assets to such an account. Sample assets are mutual funds, bonds, and real estate
There will be a tax yearly on interest and earnings generated from such assets to your kid. If your child is in a lower tax bracket, you will get some tax savings. The Kiddie tax rule, however, makes this opportunity limited.
It is possible to get some tax savings with a custodial account. However, the overall effectiveness is thwarted by the kiddie tax. Also, make sure to come to terms with other cons; for instance, any gift to such an account cannot be revoked. Your child also takes complete control of the account when they reach the maturity age – 18 or 21.
US Savings Bonds
The federal government issues various savings bonds (Series I and Series EE), which gives a unique tax benefit for college savers. These bonds are available in banks or purchased directly from the FG, and the cost ranges from $50 to $10,000.
Bonds used for education expenses that qualify will have their earnings exempt from federal income tax, provided you also meet the income limit and other minor requirements.
These bonds are supported by the credit of the FG, making them a safe investment. The yield is fair, and the Series I bond comes with extra protection against possible inflation since it offers you a fixed interest rate throughout the life of the bond.
Roth IRAs
While different from a College Savings Account, some parents use this channel to save and pay for their kid's education. Whatever you earn in a Roth IRA will not be taxed until withdrawal. Whatever you contribute there, you can withdraw anytime with some penalty.
Parents who have reached age 59.5 will not pay taxes on withdrawing their earnings because the account is more than five years old. Parents younger than this will have their income tax subjected to a 10% penalty alongside income tax. However, the 10% penalty will be waived if the withdrawal was directed to the kid's education.
Not everyone, however, qualifies for a Roth IRA as it is a value of the income. For single and head of household, they can contribute up to $6,000 to their Roth IRA.
Financial Aid Impact
How you decide to save for college can affect whatever financial aid you get and the process. When it is time for any financial assistance, the income and assets of the family will be passed using a formula both at the college and federal levels. With this, they can estimate the amount of money they expect your family to contribute to your college costs before getting any financial aid. This figure is called the expected family contribution (EFC). But, of course, the most critical determinant is your income, even though your payment also applies.
All assets from your kids are not classified the same way as yours. For example, it is compulsory for your kid to contribute 20% of his/her assets every year, while the parent contributes 5.6%of theirs. As a result, a kid that has $20,000 in his account will be expected to contribute $4,000, while you will be expected to give only $1,120 if you had the same $20,000 in your account.
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