It only takes 5 minutes to make the right choice, as long as you know the secrets of how to save money for college.
Unfortunately, many parents and grandparents don’t understand the rules, meaning they can lose thousands of dollars over time in unnecessary taxes.
Here’s the difference, in a nutshell.
Many parents save for kids using custodial accounts. They’re called “UGMA” (Uniform Gifts to Minors Act) or “UTMA” (Uniform Transfers To Minors Act) accounts depending on your state. Here in Florida, we use UTMA accounts. The money is for the child, but a parent or other adult serves as Custodian until the child reaches adulthood.
These types of accounts made a lot of sense in the old days, but the so-called “kiddie tax” rules, first introduced in 1986 and made even more draconian in 2008, turned these accounts into huge tax traps.
Under the “kiddie tax” rules, earnings are taxed each year at the parents highest marginal tax rate until the child turns age 24. For higher income parents living in a state like New York, California or Maryland, that could mean that almost half of all growth is siphoned off each year to fill state and federal tax coffers.
Contrast this with a 529 college savings plan. The money you contribute for your child or grandchild grows free of tax year after year. All that growth can be withdrawn tax-free to pay for tuition, room, board and other higher education expenses. If the child doesn’t want or need to use the money for college, benefits can be transferred to another family member or relative (even the parent, in the event they want to go back to school). Funds can be used at any accredited school in any state, as well as some institutions overseas.
The tax savings offered by a 529 plan can make the most of your savings. Here’s an example. Let’s say you save $300 per month for your child from birth to age 18, and earn a fairly modest 6% per year return. In a 529 plan, your money will grow to almost $129,000, enough to fund 4 years at most public universities with money left over for grad school or to pass on to another child. If you save using a custodial or non-529 account, and fall into a solidly middle-class 28% bracket, you’ll end up with only $107,000.
You’ve lost an entire year of tuition, room and board to taxes!
Financial Tip: With higher taxes ahead, it’s more important than ever to be tax-smart in the way you save and invest. Give us a call so we can work out the best college savings plan for you.