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What Are the Different Types of Savings Accounts for College?

4 Savings Accounts for College

  1. 529 plan
  2. Custodial account
  3. Savings account
  4. Roth IRA

By Stephen Sellner | Citizens Bank Staff

You’ve decided it’s time you start saving for your little one’s college education. That’s great! Your child might not be able to thank you now for that decision, but they certainly will later.

While most parents know they should be saving for college, the less obvious part is the question of where to put those savings.

Let’s get that squared away for you. Here are four types of savings accounts that can help you plan for your kid’s college education:

1. 529 plan

529 college savings plans are the most common way to save for your kid’s college education. That’s because there are tax advantages to the account, plus the potential to earn a return on your investment.

Here’s how it works: You open a 529 plan, make post-tax contributions to the account, and your money is invested over the course of years. 529 plans don’t have a high exposure to risk, but over time, you could earn a modest return on your contributions.

Any return you earn on your money is exempt from federal taxes. And, if you use the 529 funds for education expenses — like tuition, fees, books, and more — then your withdrawals are tax free.

If your withdrawals are not for education-related expenses, then the principal portion of the withdrawal (the amount which you contributed yourself) won’t be taxed. However, the earnings on this disbursement are classified as taxable income, meaning that money will be taxed. Plus, you could pay an additional 10% federal penalty tax on those earnings as well.

Every state — and the District of Columbia — offers at least one 529 plan. But it’s worth noting that each state’s 529 plan has a different investment portfolio since they’re separate funds managed independently of one another.

The good news? You’re eligible to apply for any state’s 529 plan, regardless of where you live! For example, if you live in Rhode Island, you could have your 529 plan with the state of Ohio, if you find that the Ohio 529 plan has a better history of producing strong returns for college savers like yourself. Private lenders also offer 529 plans.

How Do the College Savings Accounts Compare?
529 plan Custodial Account Traditional savings account Roth IRA

Post-tax contributions?

Yes

Yes

Yes

Yes

Your money is invested?

Yes

Yes

No

Yes

Tax-free withdrawals on money you contributed?

Yes, if used on education expenses

Yes, if used for benefit of child

Yes

Yes

Tax-free withdrawals on earnings?

Yes, if used on education expenses

No

Yes

Yes, if withdrawn after age 59 ½

Annual contribution limits?

No

No

No

Yes

Income restrictions to open account?

No

No

No

Yes

Ability to change account beneficiary?

Yes

No

Yes

Yes

Accept contributions from third parties?

Yes

Yes

Yes

No

Want more good news? 529s don’t have annual contribution limits or household income restrictions to open an account, and don’t have required minimal distributions. And if your kid decides not to go to college, you could change the beneficiary of the account to one of your other children or another qualified recipient, like a niece or nephew.

One last perk: 529 plans accept contributions from grandparents or any other third party.

Note: While 529s don’t have annual contribution limits, there are maximum aggregate amounts that you can contribute. These vary by plan, so consult with a financial advisor to learn more.

2. Custodial account

A custodial account is another way to save for college. Basically, a custodial account is a savings account that you, the parent, control for a minor, like your kid, until they reach legal age.

You contribute to the account like you would a 529 plan and an account manager invests the money for you. When your son or daughter reaches legal age — 18, 19, or 21, depending which state you live in — control of the custodial account automatically transfers from the parent to the child.

Custodial accounts don’t have the same tax advantages as 529 plans. Here’s what you need to know:

  • Withdrawals from a custodial account don’t have any penalties as long as the funds are used for the benefit of the child (not limited to education expenses).
  • Any return that your money earns in the custodial account is taxed. However, it’s taxed at the child’s tax rate since they technically own the account.

Custodial accounts also have no annual contribution limits or household income restrictions, but the beneficiary of the account cannot change.

While these accounts can help save for your kid’s college education, there could be some unintended consequences of saving this way. The money within the account counts as assets for your son or daughter, which could reduce their eligibility for financial aid. That’s why it may be helpful to speak with a financial advisor before saving for college through a custodial account.

Daughter and father make funny faces while on vacation.

They may seem young now, but they’ll be begging you to study abroad before you know it!

3. Savings account

This might seem like an odd college savings account suggestion, but a bank savings account can play an important, complementary role in saving for your child’s education.

Sure, the return on any contributions to a savings account is minimal, but the funds can be used for any purpose without penalty. That’s not the case with other savings accounts for college.

This can come in handy if your child decides they don’t want to attend college. The money in the account can be used for another financial goal of yours, or it could be gifted to your son or daughter to use how they see fit.

Note: For a higher return on these college savings, consider opening a high-yield savings account at a bank.

4. Roth IRA

What does a retirement account have to do with saving for college? Good question!

Yes, a Roth IRA is primarily a way to save for retirement, but some of its characteristics may make it an appealing account to save money for college.

Roth IRA withdrawals are tax free after you turn 59½, including any return earned on your contributions. (Contributions to Roth IRAs are made after taxes.) That means you can get the same tax benefits as a 529 plan if you don’t need to make withdrawals before this time.

But what if you need the money before you turn 59½? Then what? Well, you can disburse any amount of money you contributed to the Roth IRA at any time without any tax or penalty. (You also aren’t restricted to using the money for education-related expenses, either.) Note: Roth IRAs don’t have required minimum distributions until the death of the account owner.

Your earnings within the Roth IRA are a different story — withdrawing that money will be counted as taxable income and therefore be taxed. Still, your earnings will be exempt from the 10% federal tax penalty.

Roth IRAs have an annual contribution limit of $6,000 for 2019 ($7,000 if you’re at least 50 years old). However, that contribution limit could be reduced based on your income, according to the IRS.

Roth IRAs offer more flexibility than a 529 plan in exchange for fewer tax advantages. You could make contributions to the Roth IRA as supplemental college savings, and if you need the money to help pay for college, great. It’s there for you. If not, it can be used to supplement your retirement savings or any other purpose.

Remember: you have options

A 529 plan is a great way to save for your little one’s education, but it isn’t the only way. You could put some of your college savings in a 529, some in a traditional savings account, and sprinkle a little more into a Roth IRA. At the end of the day, which college savings account(s) you choose to use come down to personal preference.

And remember: your son or daughter will thank you for doing this one day!

Ready to construct your college savings plan?

Need help coming up with a college savings plan? A Citizens Bank Wealth Management Advisor can come up with the best plan for you. Want to learn more? Fill out this simple form to request a call back from an advisor.

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