Saving for college is likely a top priority whether your child is taking their first steps or entering their teenage years. On average, it cost $10,440 in tuition and fees to attend an in-state public college and $26,820 to attend an out-of-state public college during the 2019-2020 school year, according to data from The College Board.
Putting away money to cover all or a portion of these costs can ease the financial burden for your family during and after school. With less student debt to tackle after graduation, your child could get a head start on life—and that could mean they’re able to save for a house, start a family without financial stress, or stash away money early for retirement. If you’re not sure where to put your college savings, here are accounts to consider:
529 plans are state- and college-sponsored education savings plans created to help families pay for school. There are two plan types available—the prepaid tuition plan and education savings plan. Under the prepaid option, you pay for college credits today for use later when the student attends school.
The education savings version of the 529 plan is a tax-advantaged investment account. Education savings plan terms can vary and you don't necessarily have to open one up in the state where you live. Although, contributions may be deductible from your state tax return if you save in an account sponsored by your state.
You don't have to pay federal income tax on account earnings as long as you use the money on qualified education expenses, such as tuition, room and board, books, and other college costs. If you use the money for anything other than education expenses, you may have to pay state and federal income tax along with a 10% tax penalty. Because of this, 529 plan education savings accounts may be best suited for people who are fairly certain that the beneficiary will want to pursue higher education.
Fifth Third Bank offers two accounts—the Fifth Third 529 Savings Account and Fifth Third 529 CD—as part of Ohio’s CollegeAdvantage Direct 529 Plan. Ohio taxpayers who open one of these two accounts may be able to deduct contributions of up to $4,000 per year, per beneficiary from their state income taxes. APY rates range from 0.10% to 0.20% on the Fifth Third 529 Savings Account, depending on your balance, and 0.25% to 0.75% for the Fifth Third 529 CD, depending on the selected term. (These rates are current as of 7/15/20.)
Coverdell Education Savings Account
The Coverdell Education Savings account, also called the Coverdell ESA, is another account for educational expenses, but it has different rules that can be a bit more stringent.
First off, your modified adjusted gross income (MAGI) needs to be less than $110,000 (or $220,000 if you file a joint return) to open and contribute to a Coverdell ESA. Plus, there are contribution limits: For 2019, you could contribute up to $2,000 per beneficiary. The beneficiary has to be under the age of 18 when you set up the account, and the money must be used before the beneficiary turns 30 unless they have special needs.
Contributions are not tax deducible, but distributions may be tax-free as long as it's used for tuition, fees, room, board, books, or other required education expenses.
UGMAs or UTMA
Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UGMA) are custodial accounts you can use to invest in stocks, bonds, mutual funds, or other investment vehicles. These accounts aren’t designed specifically for education expenses, but you can use them to invest money for a minor’s college education.
Custodial accounts are controlled by the custodian for the benefit of the beneficiary until they “come of age,” which could be age 18, 21, or older depending on the state. Since this is not an education-specific account like the 529 plan education savings account or Coverdell ESA, there’s no penalty if your child decides to use some of the money to, say, start a business or pay for a gap year instead of using it all for college.
Savings in a custodial account may be considered an asset of the student when they apply for financial aid and this can impact their eligibility. Earnings on custodial accounts are taxable, but some may be taxed at the child’s tax rate instead of the parent’s rate. Before establishing a custodial account, speak with a tax advisor to see if it makes sense for your family.
Opening a taxable account for your education savings may give you greater flexibility and control. That's because you don’t have to follow the distribution rules of the 529 plan or Coverdell ESA, and, as the account holder (and not the custodian of your child’s account), you decide how the money is used.
Earnings on a taxable account are taxable, as the name suggests. On earnings, you may pay the long-term or short-term capital gains rate. The short-term capital gains rate is generally the same as your income tax rate; meanwhile, long-term gains may be taxed at 0% to 20% depending on your income. You could pay as little as 0% if your taxable income is less than $78,750 and 15% if your taxable income is between $78,750 and $434,550 when filing single (or $461,700 for head of household and $488,850 for joint filings). Higher-income earners could pay as much as 20% on a portion of earnings.
No matter what account you decide to open, starting to save early is the name of the game. An early start means your money will have more time to accumulate and compound. Use this guide as an overview and not a substitute for professional advice. A tax professional or financial planner can help you compare options and advise you on the best savings approach given your income and financial situation. You can also use a college investment calculator to find out your college saving options based on your MAGI.