When saving for your child’s education, saving early is the smart way to save. The sooner you start saving, the more opportunity your money has to grow. 529 college savings plans and Coverdell Education Savings Accounts (ESAs) are two options that offer tax-advantaged* ways to save. Here’s a closer look at each.
529 College Savings Plan
In these tax-advantaged accounts (which are usually sponsored by states), contributions grow tax-free, and withdrawals for eligible college expenses (such as tuition, room and board, and books) are tax-free. Depending on the state, some plans also offer state tax deductions, matching grants or other benefits. You can calculate the potential value of your state tax deduction or credit based on your taxable income with the Navy Federal College Central State Tax Deduction Calculator.
Another type of 529 plan, a prepaid tuition plan, enables you to purchase units or credits at participating schools for future tuition. This type of 529 plan is only available in some states and through the Private College 529 Plan for select private schools.
What to be aware of: If you withdraw money for other purposes (for instance, if your child doesn’t attend college or you need the money for other expenses), you’ll generally pay income tax and a 10 percent penalty on earnings. However, in the instance where a child doesn’t attend college, you can roll over funds in their 529 plan to a sibling’s without penalty. Investment options are limited to those offered by the plan sponsor, similar to employer-sponsored retirement plans, and the ability to make investment changes is restricted.
Funds in these accounts grow tax-free and are tax-free when withdrawn for K-12 or college education expenses before age 30. ESAs also offer increased flexibility. Investment options are virtually limitless, and you can make investment changes at any time.
What to be aware of: Contributions are limited to $2,000 a year per child. You’ll be subject to the same taxes and penalties as a 529 plan if the funds aren’t used for eligible expenses. The ability to contribute is subject to income limits, but children also can contribute on their own behalf.
Investing in the Future
Some parents also choose custodial accounts, taxable investment accounts, retirement accounts, savings bonds and even regular savings accounts to save for college costs. A financial advisor can help you identify your options and determine the approach that’s best for you. Your advisor can also help you understand any prepaid tuition plan options. Find a financial advisor near you or call 1-877-221-8108.
Comparing Options At a Glance
|529 College Savings Plan||Coverdell ESA|
(any qualifying withdrawals will be 100% tax free, and your investments will grow and compound tax-free while in the account)
|Qualified withdrawals can be used for K-12 expenses||X|
|Qualified withdrawals can be used for post-secondary expenses||X||X|
|Wide variety of investment options||X|
|High contribution limit (more than $250,000)||X|
|No income limits for contributors||X|
|No withdrawal age limit||X|