Understanding 4 Types of College Savings Accounts

College can be an amazing experience, but unfortunately the cost of going can be a huge barrier for many people. From tuition fees to accommodation and book costs, college is hardly a cheap few years. To top it all off, most people head off to college straight from school, without the comfort blanket of a few years of hard-earned cash in their wallet.

In order to try to prepare for this big expense, many people start saving early. Parents who may expect that their children will attend college may start putting money in a savings account when they’re just a few years old, but those who need to earn their own money to pay their way through college won’t start considering this expense until their teenage years. The amount of money you need to save will also depend on the college you decide to attend, and any financial aid that you might qualify for.

So what are the best types of accounts for those looking to get the most out of their money for college? We take a look.

529 plan

The 529 plan is designed specifically to help with education costs – from kindergarten to graduate school. The money you put into this account is not taxed whilst it’s in the 529 plan, and you can make withdrawals for free, provided that they’re for educational purposes.

There are two types of 529 plan:

  • Educational savings plan. This option means that the account holder places money in the account, which is then invested. As the beneficiary gets closer to college age, the risk level of the investments are reduced, to provide a more stable picture of how much money will be in the account when it’s needed.
  • Prepaid tuition plan. A few states offer this plan, where you can prepay your tuition costs by purchasing ‘units’ at your chosen college. The benefit of this plan is that you can ‘lock in’ the current tuition rates, so if they go up, you won’t have to pay the higher rate. However, they do not cover accommodation, purely tuition. Additionally, if you decide to change college, you might have to pay a higher rate of tuition, so you’ll then have to pay the difference in cost.

The educational savings plan is the more common of the two, and it’s your state that will decide what accounts they want to offer. They also decide how much you can contribute to the account in total.

Traditional savings accounts

Of course, many people will not be sure that they want to attend college, or may anticipate needing to have access to their savings should a big life event or emergency happen. In this case, it can be beneficial to opt for a traditional savings plan, where you simply put cash into an account without any restrictions around what you can use the money for. However, it’s important to understand that you will pay income tax and capital gains taxes on the amount earnt in this type of account.

Coverdell Education Savings Account

The Coverdell account is similar to a 529 plan, except that they have more restrictions on how much you can add to the account – $2,000 per year. This type of account is also tax-free.

This account is often popular with people who anticipate needing to use the funds for elementary and secondary school, as it can be used for wider school expenses, not just tuition. This can be reassuring for parents who are opening accounts when children are young. Additionally, if your child doesn’t go to college by the time they are 30, the money in the account will just pass to them, but get taxed.

UGMA and UTMA

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) allow money to be saved and then gifted to minors, without any restriction on what this can be spent on. This can be useful if you want to ensure that your beneficiary can use this money regardless of whether or not they attend college.

The benefit of this is that it is tax-free whilst it’s being saved – however, you should note that it will incur income tax when the money is withdrawn. Not only does this reduce the final amount of cash that you’ll be left with, but it also means that your college student might not qualify for as much financial aid.

A brighter future

College is a big expense, so starting off from a strong financial position can make a huge difference in the future. It can be hard to predict what path you or your child will follow, but considering the different types of college savings schemes available early on can be a good first step.

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