There are many different options to help you pay for college. Scholarships offer another avenue, as do student loans. Each option has its unique benefits and risks and you may want to consider more than one vehicle depending on your timeline and overall savings goals.
Comparing Your Options
Kentucky Education Savings Plan Trust
With the Kentucky Education Savings Plan Trust (KESPT) funds can be used at accredited colleges and universities in the United States — even certain colleges abroad.
KESPT can enable your savings to grow free from federal income tax on earnings and state income tax on contributions up to a certain amount.
There is no federal or state income tax on withdrawals if the money is used for qualified educational expenses, such as tuition, fees, books, and certain room and board. If your child does not go to college, you can transfer the funds to another eligible family member and preserve the tax benefits. Should you need to withdraw the money yourself, you may so long as you pay the regular income tax plus a 10% Federal penalty on any earnings. Unlike many other education savings programs, 529 College Savings Plans allow for participation regardless of income with a higher ceiling on contributions than other options.
529 State and Private Pre-Paid Plans
A 529 State Pre-Paid Plan allows you to pre-pay all or part of the costs of an in-state public college education at today’s rates. They may be converted for use at private and out-of-state colleges, and there’s also a separate Private College 529 Plan specifically for private colleges. As is the case with all 529 college savings plans, funds are exempt from federal income tax when used for qualified education expenses, but there are some caveats you need to be aware of. Funds invested in state-run prepaid plans can only be used at full value to pay for tuition and fees at in-state colleges, while funds invested in the Private College 529 plan can only be used for member colleges. In either case, room and board won’t be covered. Should your child choose not to go to school in that state or to one of the participating private schools, you may roll the funds over to another sibling attending college or withdrawal the principal — though you will likely lose most or all of your interest.
Coverdell Education Savings Account (CESA or ESA)
This is a tax advantaged education savings account similar to a 529 Savings Plan except qualifying expenditures cover primary and secondary schools in addition to college, universities and post-secondary institutions. While it can be used to cover tuition, fees and a wide variety of education related expenses, room and board costs can only be paid if a requirement of attending that school. With an ESA, you only receive federal tax advantages. If your child doesn’t use the funds, you can designate another beneficiary within the family. Coverdell ESA contributions are limited to $2,000 per year, per beneficiary. The account is not available to high income families. And you’re limited to select mutual funds and securities.
Custodial Accounts (UGMA/UTMA)
The Uniform Gifts to Minors Act and Uniform Transfer to Minors Act are ways some states allow assets such as securities to be held in a custodian’s name for the benefit of a minor without an attorney needing to set up a special trust fund. The income from a custodial account must be reported on the child’s tax return and is taxed at the child’s rate, subject to the Kiddie Tax rules. The parent is responsible for filing an income tax return on behalf of the child. There is no special tax treatment for UGMA accounts. Children aged 14 and older must sign their own tax returns.
This option includes all normally taxed accounts. Examples range from a typical bank savings account to a brokerage account. State income tax treatment varies depending on state laws. Because you’re already paying the standard tax rate, there are no penalties for non-qualified withdrawals. There are no education-specific advantages.
A Roth IRA is to retirement savings what a 529 plan is to college savings. They both allow for after-tax contributions while your earnings grow free from income tax. Withdrawals are tax-free when used for their qualified purpose. While some people choose to save for college with a Roth, there are certain restrictions: the ability to contribute to a Roth phases out at higher income levels, and there is a limit to how much you can contribute each year. It’s also worth noting that using funds from a Roth one year can hurt the student’s financial aid eligibility the next.
This is a popular retirement savings option many people use for long term investing. Because contributions are tax deferred until the owner is 59.5 years of age, the multiplier effect from compounding is greater. While there are penalty free withdrawals for qualified higher education expenses, the entire withdrawal is taxed at the owner’s tax rate. State income tax treatment varies.
Educational Savings Bonds
The savings bond education tax exclusion permits the redemption of savings bonds when the bond owner pays for qualified higher education expenses at eligible institutions. Tax free status is subject to some income limits. State income tax treatment varies.
This is an award for a student to further his or her education based on various criteria set by the scholarship creator. While scholarships do not require repayment, unless they’re full scholarships, they can affect the status of other forms of education savings.
This includes government educational aid in the form of federal and state grants and federal Stafford loans.
Grants are awarded according the rules of the proposal, which vary according to the type of grant and the organization issuing the grant. Like scholarships, they do not need to be repaid, but typically only cover a portion of a student’s educational costs.
Stafford loans by contrast require repayment, but come with a lower interest rate than most other loans.
They can be either subsidized or unsubsidized. Subsidized means the federal government will pay interest on the loan while the student is in school and has stricter qualifications. Almost any student can get the unsubsidized loan, but will be responsible for the interest accrued during their term in school. While interest rates are lower than standard private bank loans, as with any large loan, repayment will impact the borrower’s available income, possibly for decades after graduation.
Additional Student Loans
There are federal loans and a wide variety of private loans that fall outside the scope of primary government financial aid.
Parent PLUS Loans are federal loans available to parents with relatively good credit, and are made to cover the difference between the cost of attendance and any other aid your child has been awarded. While the interest rate is lower than most private student loans, it’s much higher than Stafford loans.
Private Student Loans are created by private institutions ostensibly for the purpose of helping students fund education. While Private Student Loans have better terms than many other private loans, interest rates can be much higher than government student loans, in some cases as much as 18% and many require payments while you’re still in school. These types of loans can adversely affect the borrower’s available income after graduation.