Setting aside money for your child’s future schooling is a big financial task. Because college costs are going up, it is important to start saving early and plan ahead. There are a number of tax-advantaged ways to save money that can help you get the money you need for college.
This article will talk about some of the best ways to get the most out of your investments and pay the least amount of taxes, such as Coverdell ESAs and 529 plans. A Homewood and Birmingham CPA can help you figure out how to use these techniques and help you make smart choices about your child’s financial future.
Understand the 529 plans.
You can save a lot of money for college with a 529 plan. You can put money into these state-run savings plans that you can then use to pay for qualifying school costs like tuition, fees, books, and room and board.
One of the best things about a 529 plan is that the gains grow without being taxed. In other words, you will not have to pay federal income tax on the returns from the investments until you take the money out for approved school costs.
Supercharge your 529 plan with the power of superfunding.
The best way to get the most out of a 529 plan is to do something called “super funding.” This means putting a lot of money into the plan all at once, usually all in one year. This way, you can use compound interest to your advantage and possibly see your savings grow faster.
However, it is important to know how gift taxes might affect the money you give. In the US, there are annual gift tax exemptions that say how much you can give someone without having to pay gift tax on it. By planning when you give money and maybe using the five-year giving rule, you can put more money into your 529 plan while lowering your tax bill.
Leverage 529 plans for tax benefits.
Aside from growth that is not taxed until later, 529 plans offer a number of other tax benefits:
- Tax breaks for state residents: People who live in many states can reduce or credit payments to 529 plans on their state income tax returns.
- Federal tax-free withdrawals: Withdrawals from a 529 plan are usually not taxed by the federal government as long as they are used for approved education costs.
- Possible effects on financial aid: 529 plan assets are usually seen as family assets on the Free Application for Federal Student Aid (FAFSA), but they may not have as much of an effect on financial aid status as other assets.
Coverdell ESAs are a smaller but flexible option.
The Coverdell Education Savings Account (ESA) is another tax-advantaged way to save for school. Coverdell ESAs are like 529 plans, but the yearly contribution limits are smaller, and the money can be used for a wider range of school costs, such as K–12 fees.
One great thing about a Coverdell ESA is that it can be used in a variety of ways. The money can be used for many different school costs, which makes it a good choice for parents who are not sure what their child’s future school plans are. It is important to keep in mind, though, that Coverdell ESAs have income limits and that payments are not tax-deductible.
Additional tax saving strategies for college.
A lot of employers offer 529 plans as part of their perks. You can get into these plans by having money taken out of your paycheck. You can take money out of tax-advantaged retirement accounts like 401(k)s and IRAs to pay for school without having to pay a penalty. Also, getting your kid to apply for funds and awards can help lower the cost of college generally.
By saving money in tax-advantaged ways, like 529 plans and Coverdell ESAs, you can make college much less expensive for your child by building up wealth for their future schooling.
