Military families have unique considerations when it comes to paying for their children’s college. Between state benefits, the Post 9/11 GI Bill, and other assistance, many military families wonder whether they need to save in educational savings accounts like 529 plans and Coverdell accounts.
As the parent of four college students, I feel pretty confident in saying that most people won’t be able to cover all their college costs with the various programs available. And that any savings you do have will be much appreciated when the time comes. So, let’s look at the college savings options available to you.
Coverdell Education Savings Accounts
A Coverdell Educational Savings Account (ESA) is a special type of tax-advantaged savings account for educational expenses. You can set up a Coverdell ESA with your bank or brokerage, and your investment options will vary depending on what institution you choose. Banks and credit unions typically have more limited options, such as Certificates of Deposit, while investment companies will have a wider range of options.
Annual contributions to Coverdell ESAs are capped at $2,000 per beneficiary, with a phase-out for incomes over $190,000, married, or $95,000, single. (2020 limits) Contributions are not tax-deductible.
Capital gains and earnings on investments in Coverdell accounts are not subject to federal taxes. Withdrawals are free from federal taxes as long as you use the money for qualified educational expenses, which include tuition, books, supplies, room and board, computer equipment, and internet service. This includes elementary and secondary school expenses, not just college.
One downside to Coverdell ESA accounts is that any remaining balance must be taken out by the time the beneficiary is age 30, and any amounts not used for qualified educational expenses is treated as a taxable distribution. There are ways around this, like transferring money to another beneficiary’s Coverdell ESA.
The value of all Coverdell accounts is reported on the Free Application for Federal Student Aid, or FAFSA, as a parent asset. This includes all the Coverdell accounts that the parents own, including accounts for siblings or other beneficiaries.
529 Prepaid Plans
Prepaid tuition plans allow you to purchase future tuition at today’s prices. These plans are typically administered by a state and apply to colleges and universities within the state system, but there is also a private college plan. Every plan has its own structure and rules, so be sure to read the offering carefully before making a purchase.
At this time, there are only ten states offering prepaid tuition plans, and nine of them have residency requirements. So state-run 529 prepaid tuition plans are not an option for everyone. But if it is an option for you, take a little bit of time to investigate.
There’s also the Private College 529 Plan that’s a little bit of a hybrid. You’re not buying actual tuition credits, but you are buying “certificates” for dollar amounts of tuition at participating schools. It’s a fascinating concept if you foresee a private college in your child’s future.
529 Savings Plans
What most people call a 529 plan is a 529 savings plan that gives tax-advantaged savings for future education costs. Your educational funds grow free from federal taxes, and there may also be a state tax benefit. 529 educational savings can be used at any college or university, and a portion may be used for K-12 education.
You can set up a 529 plan for anyone – even yourself – though most plans are set up for children or grandchildren. Family and friends can gift money into a 529 for future use by the beneficiary.
The money in a 529 plan remains yours, though distributions that are not used for qualified educational expenses may be subject to taxes and/or penalties, depending on the situation.
Every state offers some sort of 529 plan, but there’s no requirement that you use the plan offered by your state. Plans are also sold by a variety of independent companies, including traditional investment companies. Be sure to compare all your options, including costs, fees, and rules like where you can use the funds.
A 529 plan owned by a parent counts as a parental asset on the FAFSA, but distributions aren’t counted as income. A 529 plan owned by someone else, like a grandparent, does not count as a parental asset on the FAFSA, but distributions count as unearned income to the student. It’s important to note that all 529 plans count for each FAFSA student, even those designated for siblings or other beneficiaries. If you’re seeking need-based aid, you are going to want to strategize your 529 ownership and use for the least financial aid impact.
UGMA or UTMA Accounts
Another option to save for college expenses is a Uniform Gift to Minors Act or a Uniform Transfer to Minors Act account. These are custodial accounts, where funds are held in the name of a parent or other relative until the child reaches the age of majority in his or her state. At that point, the “child” owns the account and can use it for any purpose. This is great if you want the flexibility of using the money for something other than a qualified educational expenses. It’s not so great if you want it to be used for college and the “child” wants a new Tesla.
UGMA and UTMA do not offer any tax advantages like Coverdell or 529 prepaid or savings accounts.
From a financial aid standpoint, UGMA and UTMA accounts are counted as the child’s asset. This can be a big disadvantage because the FAFSA formula will allocate 20% of the account’s value towards the Expected Family Contribution each year, vs. 5.64% if it is an asset that is listed as being owned by the parent.
This is a pretty brief overview of your college savings options. To make the right decision for your specific situation, you need to do a lot more research, and perhaps get a little help from a professional advisor. But please don’t use the challenges of choosing prevent you from saving for education – even a little bit of money in a basic savings account is better than nothing at all. Even if you have the GI Bill!