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How do you determine the best way to leverage the investments designed to offset the high costs of college? Here are the primary advantages and drawbacks of four education-related investment accounts and what they mean for your money. With this information, we’re not attempting to tell you which college savings plan is the best. That’s up to you to decide for your family and your situation. But you can use the following information to help make your decision and start saving — or save more — for college.
Every state now offers its own 529 savings plan. Though all plans aren’t created equal, they all share a key benefit: Earnings on your investment grow tax-advantaged and aren’t subject to federal tax tax when the plans’ funds are used to cover the costs of “qualified education expenses.” Qualified expenses include tuition, fees, computer technology, books, or room and board. Anyone can establish a 529 savings plan for any future student, but those who have several years before the student will attend college will benefit the most. You’ll be expected to report your 529 plan on the Free Application for Federal Student Aid (FAFSA), and the money you have contributed will be assessed at a maximum 5.64% rate in determining the student's Expected Family Contribution (EFC). All 529 plans vary in the investment options and incentives they offer, their historical performance, management style, and fees. Though you don’t have to select the plan offered by the state you live in, there may be tax advantages to doing so. The availability of such tax or other benefits may be conditioned on meeting certain requirements.
Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest. Non-qualified withdrawals are subject to federal and state income tax and a 10% penalty. You can also purchase a 529 savings plan through Wells Fargo Advisors.
Some private school and states also offer a different type of 529 plan called a prepaid tuition plan. Essentially, the plan allows the parent to “lock in” current tuition rates that are expected to increase. The prepaid tuition plan is exempt from federal tax, and in some cases state and local taxes. With a 529 prepaid plan, anyone can make a contribution for the beneficiary, but the plan is an asset of the account owner, not the beneficiary. If the student decides not to attend college, the plan can be transferred to another beneficiary. If the child decides to attend a different college, some of the prepaid tuition balance may be applied to tuition at another school, but the family will be responsible for the difference.
There are contribution limits to an ESA based on modified adjusted gross income, and contributions cannot exceed $2,000 per beneficiary per year. If you qualify, funds deposited in an ESA grow tax-advantaged. If the distributions do not exceed the enrolled student’s education costs, they may not be taxed either, provided the funds are used for expenses at a qualified educational institution that requires tuition — including private elementary and secondary schools. If the distribution exceeds the expenses related to education, the earnings portion is subject to federal tax at 10% (contribution amounts when withdrawn are not taxed). Unused balances can be rolled over to another family member before the beneficiary is 30 years old, or the amount will also be taxed at 10%.
Custodial accounts used to be a popular way to give money to a child to help pay for college expenses, but there are risks to consider: Once money is put into a custodial account for a child, it belongs to the child, and the beneficiary cannot be changed. The beneficiary could determine not to use the money for college once he or she turns of “legal age” on the account (which could be as young as 18). Unlike a 529 plan, a significant balance in a custodial account could also reduce the child’s financial aid eligibility. If the account exceeds $1,000, he or she may also have to pay significant taxes on the money under “kiddie tax” laws. You can legally gift up to $14,000 to a child (as could your spouse) and not be required to pay taxes on the gift or file a gift tax return.
Though there are many investment tools designed to help prepare for the costs of higher education, their features and benefits can be very different. Do your research and start saving early to reap the most potential from whatever investment you choose.
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Source: FinAid.org, “Section 529 Plans.”
Source: IRS.gov, “Coverdell Education Savings Accounts."
Source: Market Watch, “5 things to know about custodial accounts for kids.”
This information is provided for educational and illustrative purposes only.
Wells Fargo Wealth Management provides products and services through Wells Fargo Bank, N.A., and its various affiliates and subsidiaries.
Wells Fargo & Company and its affiliates do not provide tax or legal advice. Please consult with your tax and legal advisors to determine how this information may impact your own situation.
Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Past performance does not indicate future results. The value or income associated with a security or an investment may fluctuate. There is always the potential for loss as well as gain.
Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company.
The amount of money that a student's family is expected to contribute to college costs for one year. Financial need is calculated as the difference between the cost of attending school and the expected family contribution. The EFC considers family income, assets, size of current household, and the number of family members currently enrolled in college.