College Savings Options

HYG-5250
Date: 
06/09/2020
Roseanne E. Scammahorn, PhD, Extension Educator, Family and Consumer Sciences, Ohio State University Extension, Darke County

For many, a college education is something they dream of, and with proper planning, it can become a reality. According to The Federal Reserve (May 2019) the typical amount of education debt in 2018, among those with any outstanding balances, was between $20,000 and $24,999. Ohio residents are slightly above the national average debt ($28,650) at $30,629 at the time of graduation with 62% of students having some form of college loan (The Institute for College Access & Success, 2018). Pre-planning for the cost of a college education can significantly reduce the burden a student loan may be on a college graduate entering the workforce.

Starting to save for college is a great goal to aspire for, but it should not be the only goal. Financial experts recommend saving for retirement should be a priority. Only with additional funds, should a college savings be pursued. Students have many avenues to help reduce the cost of college, like grants, scholarships, and work-study programs, but retirement planning should not be neglected.

There are many ways that parents, grandparents, and other interested persons can save for a child’s educational expenses. When choosing an option there are several factors to be considered:

  • eligibility
  • contribution limits
  • tax implications for deposits and withdrawals
  • savings and investment options
  • guidelines for what the funds can be used for without penalty
  • who has control over the account
  • impact the savings will have on opportunity for financial aid
  • transferability of funds

College Savings Options 

The following listing outlines several college savings options available and basic information on each. It is advised to work with an accountant or financial consultant for specifics on each plan prior to investing in a college savings option. As with any investment account, there may be associated fees which should be considered in any college savings strategy.

 

Coverdell Education Savings Account
(formerly known as Education IRA)

Eligibility: Parents, grandparents, other relatives, friends, and the child for whom the account is being established can contribute to a Coverdell ESA. If adjusted gross income is $110,000 or more ($220,000 if filing a joint return), you would not be eligible to use a Coverdell ESA.

Contribution Rules: $2,000 (after tax) per child, per year. No additional funds may be added once the child reaches age 18. Must use account by age of 30.

Tax Implications: Tax-free investment growth and tax-free withdrawals when the funds are spent on qualified education expenses. Contributions are not tax deductible.

Savings/Investment Options: Growth rate will vary based on the investments in the account. Owner of the account controls the investments.

Use Guidelines: College tuition, fees, books, supplies, equipment, special needs; room and board for minimum half-time students; plus, there are additional categories of K-12 expenses that are approved.

Control: The trustee or custodian will administer the account for the benefit of the child. Ownership can be transferred to the child once they reach the age of majority (age 18 in OH). Other states will vary.

Affect on Financial Aid: Withdrawals taken from parent- or student-owned accounts will be excluded from federal income tax return, but if a grandparent or someone else owns the account the amount of the withdrawal will be “added back” and counted as student income on the following year's FAFSA. This could impact financial aid.

Transferability: The account can be transferred to a different beneficiary, as long as that person is an eligible family member of the original beneficiary.

 

529 Plan

Eligibility: Anyone can set up a 529 plan and name anyone as beneficiary – a relative, a friend, or even yourself. 

Contribution Rules: Up to $15,000 per child. Individuals may contribute as much as $75,000, for catch-up, to a 529 plan if they treat the contribution as if it were spread over a 5-year period. There are no annual contribution limits.

Tax Implications: Account grows tax-free and qualified withdrawals are free from federal and state income tax. For Ohio taxpayers, contributions to a 529 account may qualify for a deduction from taxable income, up to $4,000 per child each year.

Savings/Investment Options: 529 savings plans generally invest in mutual fund-based investments where the account value is based on investment performance.

Use Guidelines: Tuition, fees, books, computers and related equipment, supplies, special needs and some room and board at eligible colleges and universities; up to $10,000 in tuition expenses at private, public, and religious K-12 schools.

Control: Whoever purchases the 529 plan is the custodian and controls the funds until they are withdrawn.

Affect on Financial Aid: Funds invested are considered to be an asset of the account owner – if that is a parent, only 5.64% of the value of the account is considered to determine the student's expected family contribution. 

Transferability: The account can be transferred to a different beneficiary at any time, as long as that person is an eligible family member of the original beneficiary.

 

529 Plan: Pre-Paid Tuition Plans

Eligibility: Not currently available in Ohio. Participating states: Parents, grandparents, and others to prepay tuition at today’s tuition rates at eligible public and private colleges or universities, helping them manage future tuition costs.

Contribution Rules: You pay for amounts of tuition (years, credits, or units) in one lump sum or through installment payments.

Tax Implications: Benefits vary depending on the state and the 529 plan. Tax-free earnings are not subject to federal income tax and, in many cases, state income tax. Withdrawals for non-qualified events are subject to state and federal income taxes and an additional 10% federal tax penalty.

Savings/Investment Options: Education savings plans have certain pre-set investment options. It is not permitted to switch freely among the options. Under current tax law, an account holder is only permitted to change his or her investment option twice per year or when there is a change in the beneficiary.

Use Guidelines: Tuition and mandatory fees at current prices. Prepaid tuition plans usually cannot be used to pay for future room and board at colleges and universities and do not allow you to prepay for tuition for elementary and secondary schools.

Control: Whoever purchases the 529 plan is the custodian and controls the funds until they are withdrawn.

Affect on Financial Aid: Funds will generally impact a student’s eligibility to receive need based financial aid for college.

Transferability: If a beneficiary doesn’t attend the pre-paid tuition participating college or university, the funds can be used at another university, but you will lose the guaranteed tuition benefit. Most prepaid plans also let you transfer the plan to a child's brother or sister.

 

Custodial Account: Uniform Gifts to Minors (UGMA) or
Uniform Transfer to Minors (UTMA)

Eligibility: Parents, grandparents, relatives, and friends can make irrevocable transfers to the account.

Contribution Rules: Up to $15,000 per child per year. Contributions treated as completed gift.

Tax Implications: Earnings and gains taxed to minor; first $1,050 of unearned income (interest, dividends, or capital gains) is tax exempt; second $1,050 of unearned income is taxed at child's rate; unearned income over $2,100 for children under age 18 is taxed the higher of the child’s or parents’ rates.

Savings/Investment Options: Multiple investment options including cash or securities.

Use Guidelines: May be rolled over to a 529 Plan. At age 18, student has complete control, whether or not funds are rolled over to 529 plan. Student owns the assets even if he or she decides not to go to college.

Control: Transfer is irrevocable. At age 18, student has complete control of the account. If the donor dies before the funds are turned over to the student, the account becomes a part of the donor’s estate.

Affect on Financial Aid: It is considered to be the assets of the minor and counts toward the amount the student is expected to contribute toward college expenses.

Transferability: Irrevocable transfer from owner when student reaches 18.

 

Traditional IRA

Eligibility: Owner of account must be employed, receive a taxable income, and under the age of 70 1/2.

Contribution Rules: Maximum contribution to an IRA is $5,500 per person, with an additional $1,000 catch-up for account owners over age 50, for a total of $6,500. Contribution limit phases out for those who participate in employer retirement plans and have an income above certain limits.

Tax Implications: The entire withdrawn amount will be subject to federal and state income tax.

Savings/Investment Options: Permitted investments for IRAs are individual stocks, bonds, CDs mutual funds, and annuities.

Use Guidelines: 10% penalty is waived for qualified higher education cost but are still subject to income tax. Eligible expenses include tuition (but not room and board), books, equipment, and fees (IF required by the school). Must be used for the education of the account owner, their spouse, children, or grandchildren.

Control: Owner of account must be employed, receive a taxable income, and under the age of 70 1/2.

Affect on Financial Aid: Not counted as asset. Withdrawals of principal and interest counted as financial aid income.

Transferability: Only to beneficiary.

 

Roth IRA

Eligibility: Owner of account must receive a taxable income. Specific limits are based on modified adjusted income.

Contribution Rules: Maximum contribution to an IRA is $5,500 per person, with an additional $1,000 catch-up for account owners over age 50, for a total of $6,500. Contribution limit phases out at specific income levels.

Tax Implications: Funds withdrawn above and beyond the original contributions will be taxed at federal and state levels.

Savings/Investment Options: Permitted investments for IRAs are individual stocks, bonds, CDs, mutual funds, and annuities.

Use Guidelines: 10% penalty is waived for qualified higher education cost but are still subject to income tax. Eligible expenses include tuition (but not room and board), books, equipment, and fees (IF required by the school). Must be used for the education of the account owner, their spouse, children, or grandchildren.

Control: Owner of account must receive a taxable income.

Affect on Financial Aid: Not counted as asset. Withdrawals of principal and interest counted as financial aid income.

Transferability: Only to beneficiary.

 

U.S. Savings Bonds

Eligibility: Anyone. Bond purchaser must be at least 24 years old at time of bond issuance.

Contribution Rules: $10,000 face value per year, per owner, per type of bond (Series EE and I) for a total of $20,000.

Tax Implications: The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible bonds (Series EE and I) issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.

Savings/Investment Options: Bonds are available in various denominations. Interest rate on I Bonds is a fixed rate with semiannual inflation rate. EE Bonds have a fixed rate when purchased after May 2005. I & EE Bonds can be redeemed after 12 months. However, if redeemed before it is five years old, you lose the last three months of interest.

Use Guidelines: Tuition and fees. Note: The costs of books or room and board are not qualified expenses.

Control: Owner.

Affect on Financial Aid: Counted as asset of bond owner.

Transferability: Not applicable.

 

401 (K) and 403 (B) Retirement Plans

Eligibility: Must be employed. If plan allows you to take a loan for college, it much be repaid typically within 5 years. If you leave your employment, the loan is due within 60 days of the job loss.

Contribution Rules: Annual contribution limit from employee is $18,500 ($24,500 if age 50 or older). Established by the plan provider based on federal guidelines.

Tax Implications: Withdrawals prior to age 59 1/2 are federal income tax free when used for qualified higher education expenses but you may have a 10% penalty fee. If you leave employer, balance must be paid in full. If unable to pay in full, the loan proceeds would be treated as taxable income and would also be subject to a 10% early withdrawal penalty, if age 55 or younger.

Savings/Investment Options: If not a self-directed brokerage account arrangement, options typically limited to those made available in the plan.

Use Guidelines: Tuition, room and board, and other related expenses. 

Control: Owner.

Affect on Financial Aid: Balances in retirement accounts are not considered in federal financial aid formulas. However, withdrawals, even for qualified higher education expenses, are considered income. If from a parent owned account, 0% to 47% of the withdrawal is applied to expected family contribution the next year. If from a student owned account, 0% to 50% of the withdrawal may be applied. The exact percentages depend on multiple factors associated with family and student income.

Transferability: Only to beneficiary.

 

Personal Investment Accounts (Mutual Funds)

Eligibility: Anyone.

Contribution Rules: No limit.

Tax Implications: Deposits not tax deductible. Owner taxed on investment interest and earnings.

Savings/Investment Options: Unlimited. Normal investment risks apply.

Use Guidelines: None.

Control: Owner.

Affect on Financial Aid: Counted as assets of parents/owner.

Transferability: Not applicable.

 

Additional Resources

Check the date of the publication to ensure you are receiving the most up-to-date information.

Compare Savings Options – savingforcollege.com/compare_savings_options 

Coverdell ESA – irs.gov/taxtopics/tc310

Financial Industry Regulatory Authority – finra.org/#

Morning Star: Stocks, Mutual Funds and Investments – morningstar.com

Series EE Savings Bonds – treasurydirect.gov/indiv/research/indepth/ebonds/res_e_bonds.htm

Series I Savings Bonds – treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm

529 Plans – savingforcollege.com

 

References

Board of Governors of the Federal Reserve System. (May 2019). Report on the economic well-being of U.S. households in 2018. Retrieved from federalreserve.gov/publications/files/2018-report-economic-well-being-us-households-201905.pdf

Clark, K. (2019). Roth and traditional IRAs for college savings accounts. Retrieved from thebalance.com/ira-college-savings-accounts-795254

FinAid. (2019) Retirement plans and saving for college. Retrieved from finaid.org/savings/retirementplans.phtml

Financial Industry Regulatory Authority. (2019). 529 prepaid tuition plans. Retrieved from finra.org/investors/learn-to-invest/types-investments/saving-for-education/529-prepaid-tuition-plans

Flynn, K. (2019). How much can you contribute to a 529 plan in 2019? Retrieved from savingforcollege.com/article/how-much-can-you-contribute-to-a-529-plan

Ohio’s 529 College Advantage. (2019). Let’s define Ohio’s 529 plan. Retrieved from collegeadvantage.com/new-to-collegeadvantage/what-is-a-529

The Institute for College Access and Success. (2018). Student debt and the class of 2017. Retrieved from ticas.org/?s=Student+debt+and+the+class+of+2017

Treasury Direct. (2012). Treasury department sets online savings bond annual purchase limit at $10,000 per series. Retrieved from treasurydirect.gov/news/pressroom/pressroom_purlim0112.htm

U.S. Securities and Exchange Commission. (2018). An introduction to 529 plans. Retrieved from sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html