529 plans are a very popular college savings option, thanks in big part to their flexibility and tax perks.
For most people, 529 plans have plenty of room for growth. The contributions for these plans are considered gifts for tax purposes. So that means you can contribute up to $15,000 per account, and so can your spouse, without incurring the gift tax. Gift tax applies if you, as an individual, contribute more than that. It ends up counting against your lifetime estate.
You can use 529 plans for “education expenses,” a broad range of qualifying expenses. And, as of recently, you can spend up to $10,000 per year of your 529 plan on tuition for k-12 education. Be aware that some state, like Massachusetts, will tax the distributions used for k-12 expenses. About a dozen states consider k-12 distributions non-qualified expenses, and the earnings portion of the withdrawal is subject to the state income tax.
If that does feel too limiting to you – or there are other aspects of the 529 plan that you’re not on board with – you do have some other good options.
Joint Brokerage Account
A joint brokerage account is another popular option for saving up for your child’s education. What I like about this is that you, as a parent, have the freedom to gift your child the account whenever you’d like. There aren’t any age limits or restrictions about how the money can be spent. And you can pretty much invest it however you’d like.
You can use the money in this account for college, or even for a down payment on a home or a wedding gift.
Here’s a rule of thumb I like to use: If you’re a mid-income earner and are expecting to have about 50% of school costs paid for in the 529 plan, I would recommend setting up a joint brokerage account. The same goes for high-income earners who plan to have 75%-100% of school paid for. That’s because mid-income earners who make about $75k-$150k are likely to get some financial aid, but high-income earners probably won’t qualify.
When it comes to withdrawing money, you can pull out whatever you want for any reason, at any time. There aren’t any penalties to deal with. The trade-off for that flexibility is that you don’t get the tax breaks you’d get with a 529 plan for education expenses.
You can set up a joint account between you and your spouse and contribute as much as you want. You’re not limited to how much you can contribute. This account can then be gifted for education costs, or even for a milestone like buying a house or getting married.
The Uniform Transfer to Minors Act (UTMA) gives parents and family members the ability to transfer an account to a child when they reach a specific age, usually 18-21. It was a pretty popular choice prior to 529 plans.
But a big difference between these plans is that there aren’t any tax breaks for using a UTMA to pay for education. It’ll be subject to income taxes regardless, unlike 529 plans.
Another important point: The UTMA account is considered the child’s. So, when it comes time for them to go to school, they have to sell securities to get the money. Any capital gains over $2,000 will be subject to taxes, so your child will have to submit a tax return.
Also be aware that your child gets ownership of this account at 21 years old. Most parents typically prefer to control the money a bit longer, and save it for when their child is getting married or buying a house later on.
A UTMA account is still an option, but given the restrictions, I still recommend looking into a 529 plan or brokerage account for your child’s education first.
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