FABULESSLY FRUGAL FRIDAY: Saving for Your Children’s College Education-Part III

*DISCLOSURE: Although I took a few grueling finance classes in college, that is not what I obtained my degree in. I am not an expert. Not even close. In fact, to even allude to the fact that I am a Finance Expert would make my husband giggle (except boys don’t giggle, so maybe something more manly like chuckle?). Basically what I’m saying is this entire article is solely my opinion. PLEASE check with someone smarter than me before making any major financial decisions.

I had to delay the final part of this series last week because of a much needed vacation. But now that it’s back to reality, I’ll tackle Part III (Did you miss part I or Part II?).  This week we’ll cover Roth IRAs, Coverdale Education Savings Accounts and UGMA (or UTMAs). These are the least popular options out there based on my research. Most financial experts agree that of the three, Coverdale ESAs are the best option, but exploring 529 accounts is better still.

Roth IRAs

Roth IRA accounts are used primarily for individual retirement savings, but you can use the accounts for higher education savings. While you do not want to use a Roth IRA account as your primary source of education funds, a Roth IRA is a great account if you are trying to save for college and retirement.

To explore this concept, let us review the basic rules for a Roth IRA account. Contributions and earnings for a Roth IRA account have separate rules.

Basic Rules for Contributions:

  • Roth IRA contributions are not tax deductible.
  • Contributions can be withdrawn from a Roth IRA account at any time. For example, if you deposit $5,000 in 2009 and 2010, you can withdraw $10,000 from your account in 2010 without tax or penalty because the $10,000 is the original contribution.
  • The contribution limits for Roth IRAs are as follows:

  • 2009: $5,000 per year, with a $1,000 catch-up contribution for those older than 50.

Basic Rules for Earnings:

  • Distribution of earnings from a Roth IRA account must meet the following criteria to be tax-free and penalty free:
    • The distribution is made five years after the initial contribution and one of the following:
      • Distributions are made after attaining age 59½;
      • The account holder becomes disabled;
      • For the purchase of the account holder’s first home, or
      • The distribution is due to death.
  • Earnings can be withdrawn from a Roth account after five years without penalty; however, taxes will be due if the distribution is used for qualified higher education expenses.

When a distribution is made from a Roth IRA account, contributions are considered withdrawn first. For example: If you have an account worth $10,000 ($8,000 is contributed money and $2,000 is earnings), and you withdraw $6,000 today, there is no tax consequence or penalty as contributions are pulled from the account first.

Advantages of a Roth IRA

  • Tax-free, penalty-free withdrawal of original contributions
  • Tax-free growth until the time of withdrawal
  • Flexibility

Disadvantages of a Roth IRA

  • Subject to income taxes upon withdrawal
  • Depletes your retirement savings

Coverdale Education Savings Accounts

A third college savings option is to fund a Coverdell Education Savings Account (ESA). Coverdell accounts work much like 529 accounts: Contributions are not deductible, but distributions are tax free as long as they’re used for qualifying education expenses. Also, like 529 accounts, anybody can be named as the beneficiary, and the beneficiary can be changed at any time.

The primary differences between 529 accounts and Coverdell accounts are that:

  • Coverdell accounts can be used for grade school or high school education expenses,
  • Contributions to a Coverdell account are limited to $2,000 per year (In a 529 plan, the limit is set by the state–usually far above $2,000 per year.),
  • Contributions to a Coverdell do not qualify for a state income tax deduction.
  • You can invest the money in a Coverdell account in any way you choose.

UGMAs

The Uniform Gifts for Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA) are similar in almost all respects.

UGMA and UTMA accounts are a way for children who are not of age of majority — younger than 18 in most states and 21 in others — to own securities (stocks, mutual funds, bonds, etc.).

Control of Accounts

With an UGMA/UTMA account, the individual who is responsible to oversee and manage the account is referred to as the “custodian.” (The person who opens the account doesn’t have to be the custodian.) The custodian is legally bound to judiciously manage the funds in the UGMA/UTMA account: He or she cannot use the funds to bet or gamble, for example.

On reaching the age of majority, the minor can assume control over the account without the custodian’s consent.

Tax implications

  • UGMA/UTMA is subject to a gift tax exclusion that allows an individual to give up to $11,000 per year to another person without being subjected to the gift tax.
  • The first $750 in earnings each year is free from federal taxes and the next $750 is taxed at the child’s tax rate. Afterward, earnings are taxed at the normal rates.

UGMA and UTMA accounts can be rolled over into 529 plans: This is popular because of 529s’ more generous tax benefits and account ownership flexibility.

And there you have all the information regarding saving for your child’s college education that this pea-sized brain of mine can hold. After all of my research, I’ll be looking into 529 accounts, but I also firmly believe in getting my children involved in earning money for their own education. My husband and I might make the biggest dent, but they will definitely be contributing!

Comments

  • Debra

    FYI, the word is “allude” not -elude-.

    • Amber

      Debra, that’s funny on so many levels. First being I’m an English major (who has obviously done nothing w/ said degree for way too long). Second, I get on to my friends all the time for their, there and they’re, and the big joke is when one of them will catch me using a word incorrectly. Hush! This will be our little secret!

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