29 Jan The best way to save college money for a toddler

Q. Looking for advice for starting a college account for my toddler. We both have separate savings accounts for him but would like to invest it properly. What should we do?
— Mom

A. We’re glad to see you’re planning ahead because your child’s college tuition can be one of the largest expenditures you will ever make.

Whether they choose to attend a private or public university, taking the necessary steps to start saving today is not only a wise decision, but it will reap greater benefits the earlier you begin, said Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany.

Without knowing the details of your specific situation, Green said he’s going to assume the savings accounts you have already opened for your son are regular bank savings accounts. In this case, the funds wouldn’t have much potential to grow, and should likely be moved to a more appropriate savings vehicle, he said.

The most popular educational savings method is the 529 College Savings Plan.

“Created by Congress in 1996, a 529 plan is a tax-advantaged investment account sponsored by a state or state agency,” Green said. “When ready to be used, the funds can be withdrawn and applied toward tuition, books and other qualified education expenses at most accredited two- and four-year institutions.”

As of 2018, 529 plans can also be used to pay tuition for K-12 education, although there is a limit in place of $10,000 per child, he said.

If you choose to save for college in a taxable brokerage account instead of a 529 plan, you will potentially be required to pay taxes on realized capital gains, Green said. This is not so with a 529 plan.

“Due to its tax-advantaged nature, your investment earnings compound on a tax-free basis, and the withdrawals are tax-free as well,” he said.

It is important to note that there are many different investment options inside of each state’s 529 plan. Green recommends you compare each state’s plan and decide which one best suits your needs. As long as you use the funds for approved educational purposes, you will not be responsible for paying taxes on the growth.

Another option is the Coverdell Education Savings Account (ESA).

While both Coverdell ESAs and 529 plans can be used to pay for qualified higher education expenses—as defined by the IRS—the rules differ regarding K-12 expenses. Tax-free withdrawals from 529 plans are limited to only K-12 tuition, while Coverdell ESAs can be used to pay for any K-12 qualified expenses, he said.

This may sound like a great benefit, Green said, but you’re only able to contribute $2,000 per year for each beneficiary to a Coverdell ESA, and only until they turn 18.

“Funds in the account must be spent by the time the student turns 30, and at that time, any funds not withdrawn within 30 days may be subject to taxes and penalty,” Green said. “To avoid this, you can change the beneficiary on the account to another qualifying family member or roll the balance into a 529 plan.”

Another key difference between a Coverdell ESA and a 529 plan is that the funds in a Coverdell ESA are technically the property of the beneficiary and cannot be revoked, Green said.

But with a 529 plan, the account owner – not the beneficiary – retains control of the assets over the life of the account.

Green recommends you speak with a financial planner to get a clear picture of the projected need, how much you should be contributing to the account and appropriate asset allocation.

“You will want to decrease the risk of the portfolio as your child ages and gets closer to their time of enrollment,” he said. “Remember, even if your goal seems overwhelming now, proper planning and saving can put the cost of college within reach.”

You can learn more about 529 plans here.

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