Know which options work best for you and plan early.
With the cost of higher education rising, it’s important to determine how you and your family will fund it. There are several options to consider, each with their own pros and cons.
How much time you have to save, your access to liquidity and the types of accounts and assets you already possess can push you toward one vehicle over another. Here are five of the most popular methods of funding education.
This flexible, state-sponsored savings account covers qualified primary, secondary, and college expenses, as well as qualified U.S. apprenticeship programs and some abroad. Investments are usually in mutual fund-like portfolios, with fixed income options available. A 529 can have certain incentives exclusively for residents of the state the 529 is administered in.1 In a typical 529 plan:
These behave similarly to a regular 529 savings plan but allow you to prepurchase a certain percentage of tuition credits for in-state postsecondary programs that are guaranteed to be the equivalent of the future cost.
While not carrying any special provision for educational use, the Uniform Gifts/Transfers to Minors Act (UGMA/UTMA) lets you transfer assets to your child without setting up a costly trust. You can transfer cash, bank accounts, stocks, bonds, mutual funds, real estate, limited partnerships, fine art, patents, and royalties (for UTMA). Features include:
Once called the “education IRA,” this savings alternative is a trust or custodial account for educational expenses, which can include a wide range of securities. Features include:
In some cases, you can withdraw tax-free funds from a Roth IRA for qualified higher education expenses. But, considering it’s your retirement fund, use this option cautiously.2
1 Certain conditions may apply. Earnings in 529 plans are not subject to federal tax and in most cases state tax, as long as you use withdrawals for eligible education expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible education expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover education costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. An investor should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
2 Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted.
