Planning for your child’s college education can be daunting, but with the right strategies, you can make it manageable. In this article, we’ll explore various college savings options, including 529 plans, Roth IRAs, Coverdell Education Savings Accounts, brokerage accounts, and high-yield savings accounts. Each option has its pros and cons, and understanding them can help you make the best decision for your family’s future.

1. 529 Education Savings Plans

A 529 plan is a state-sponsored investment account with tax perks that help families save for school. Money in a 529 savings plan can be invested in various assets, such as mutual funds and exchange-traded funds (ETFs). The main advantage of 529 plans is that investment earnings aren’t taxable as long as you use the funds for qualifying education costs.

Pros of 529 Plans

• Possible tax breaks: In some states, contributing to a state-sponsored savings plan qualifies you for a state income tax deduction or credit.
• Funds are transferable: You may be able to change beneficiaries or transfer funds to another 529 savings plan if the original beneficiary decides not to go to school or doesn’t use all the money in the account.

Cons of 529 Plans

• Steep penalties for non-education withdrawals: If you use education savings for other expenses, account earnings are subject to income tax, and you could get hit with a 10% tax penalty with some exceptions.
• Investment restrictions: Your 529 plan may limit you to certain portfolio options, giving you less freedom to choose individual stocks, bonds, or ETFs.

2. Roth IRAs

A Roth IRA is a tax-advantaged retirement account designed to help you save for the golden years—but funds may also be used for college. Money in a Roth IRA grows tax-free, and you can withdraw funds before retirement without paying an early withdrawal penalty if the money is used to cover education costs.

Pros of Roth IRAs

• Money left over can be used for retirement: If your children decide not to go to college or you have money remaining after paying for school, you can keep the funds for retirement.
• No tax penalty for education withdrawals: Withdrawing money for college is one of the few reasons you can take money out of a Roth IRA before age 59½ and not incur the 10% early withdrawal penalty.

Cons of Roth IRAs

• Reduced retirement savings: Taking money away from your nest egg to pay for a child’s college education could throw off your retirement plans.
• Income and contribution limits: In 2023, your modified adjusted gross income must be below $153,000 if filing single (and $228,000 if filing jointly) to contribute to a Roth IRA.

3. Coverdell Education Savings Accounts

Coverdell education savings accounts are trusts or custodial accounts for education costs you can open for someone under 18 years old or with special needs. You don’t have to pay tax on investment earnings when you use cash in the account for qualified education expenses.

Pros of Coverdell Accounts

• Tax perks: Account distributions are not taxable as long as you use the money for education expenses and the withdrawal doesn’t exceed your qualified educational expenses.
• The account is transferable: If the account beneficiary doesn’t use all of the money for school, it can be transferred to a family member to help them save and pay for college.

Cons of Coverdell Accounts

• Income limits: For 2023, your modified adjusted gross income has to be below $220,000 when filing jointly (or $110,000 for single filers) to contribute to a Coverdell education savings account.
• Age limits: The money must be used or transferred out of the account before the beneficiary turns 30 years old unless they have special needs.

4. Brokerage Accounts

Taxable brokerage accounts don’t offer the tax breaks you’d get with education savings accounts, but they do provide greater flexibility since there are no contribution or withdrawal restrictions. The advantage here is you can deposit as much as you want and take money out of the account for any reason without penalty.

Pros of Brokerage Accounts

• Personalized investments: After opening a taxable account, you can invest in a wide range of assets to create your own portfolio.
• Fewer restrictions: You can deposit money into the account without limits and use the money to cover a child’s education or any other coming-of-age expense.

Cons of Brokerage Accounts

• Capital gains tax: Withdrawals from taxable accounts are subject to capital gains tax, which means you have to give Uncle Sam a cut of your investment earnings.
• No annual state tax break: Contributions to a taxable account won’t qualify for education savings tax perks like state tax deductions or credits.

5. Savings Accounts

Putting money in a savings account that offers a high annual percentage yield (APY) could be a good option for college savings you plan to access in the near term. Today, APYs for high-yield savings accounts range from 3% to 5%, which could provide you with a decent return on money you plan to use within the next year or two.

Pros of Savings Accounts

• Easy to get started: You might already have a savings account you can start using to save for college expenses.
• Freedom to use money the way you choose: You can use money in your savings account for any expense without worrying about withdrawal penalties if you don’t use the money for education costs.

Cons of Savings Accounts

• No tax breaks: Contributing to a traditional savings account won’t qualify you for the same tax incentives available when depositing money into certain education accounts.
• Earnings may be limited: Saving in a traditional savings account might not provide a return as high as investing in the market over an extended period.

The Bottom Line

Putting even small amounts of cash away for college can reduce the amount of money you need to borrow to get an education. And if you’re unsure which type of savings account would provide the best tax advantages for your family, consider scheduling an appointment with a financial advisor to discuss college planning.

At O1ne Mortgage, we understand the importance of financial planning for your family’s future. If you have any mortgage service needs, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you navigate the complexities of mortgage options and find the best solution for your needs.