Most states offer at least one plan. The beneficiary does not have control over the funds in the account, even when they reach the age of majority, which is between the ages of 18 and 21, depending on the state.
Learn about the gift tax. The vast majority of people do not need to worry about this since they are unlikely to need to contribute that much per year to meet their savings goals. A plan can also be used to pay for private or religious elementary, middle and high school tuition. There is no penalty on the principal. There are a few exceptions: If the beneficiary receives a scholarship, you can withdraw money equal to the amount awarded; the earnings will still be subject to taxes but there will be no additional penalty.
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Investor education. Tools and calculators. Contact us. Open an account with Merrill. Using plans to invest for college and transfer wealth Share:. Text size: aA aA aA. Paying for a child's or grandchild's college education is an expensive proposition, even for many high-net-worth Americans. Today's elite institutions promise graduates a rewarding future, but at a cost that more often than not extends well into six figures. Enter the plan , a tax-advantaged investment vehicle generally available to families regardless of their income level.
For affluent parents and grandparents, a plan offers a variety of potential benefits — including some that go beyond the scope of college planning. A plan may in fact play an integral role in an estate plan. Named for the section of the Internal Revenue Code that authorizes them, plans allow investment earnings to potentially grow while remaining sheltered from federal income taxes, and withdrawals used to pay for qualified education expenses are tax-free.
Gifts can also be made via cash or check to the account owner, or with Gift of College gift cards. The amount each parent needs to save will vary based on the age of their child and what type of school they will attend.
The table below illustrates current college costs and the recommended amounts to save each month for a future student. Assumes current inflation rates of 3. All other expenses are non-qualified. If the designated beneficiary decides not to go to college , you can always change the beneficiary to another qualifying family member , save the funds for a future grandchild or use the money to further your own education. Or, you can take a non-qualified withdrawal at any time for any reason.
Only the earnings portion of the distribution will incur taxes and penalty. Your contributions the principal will never be taxed or penalized since they were made with after-tax dollars. Technically, prepaid tuition plans are also plans, but everybody calls them prepaid tuition plans. Hardly anybody calls them prepaid plans any more. A prepaid tuition plan locks in tuition at current rates by letting you buy tuition units or years of tuition.
But, you will usually have to pay a premium on current tuition rates, to make up the shortfall between investment returns and increases in college costs.
Many prepaid tuition plans are suffering from actuarial shortfalls and do not have enough money to cover all future tuition obligations. Some prepaid tuition plans offer guarantees, but their guarantees may not be backed by the full faith and credit of the state. Many prepaid tuition plans have closed to new investment and will not cover full tuition costs.
All insurance products are governed by the terms in the applicable insurance policy, and all related decisions such as approval for coverage, premiums, commissions and fees and policy obligations are the sole responsibility of the underwriting insurer. The information on this site does not modify any insurance policy terms in any way. Americans have been slow to embrace college savings plans , which were introduced in the mids. A plan allows you to invest in high-return assets, avoid taxes on the capital gains while in the account and then withdraw those earnings tax-free for qualified education expenses.
While tax-free investing can be a major upside, the plans have some downsides, which may help to explain why so few people know about them or use them. A plan may allow you to invest in a number of different assets, including stock funds, bond funds, and FDIC-protected money market accounts.
But plans are administered by each individual state, and the plans may not offer an attractive investment opportunity, depending on which plan you choose. For example, some state plans may offer only high-cost funds or a limited selection of funds. For those with investment expertise, that can be a significant downside over investing the money in more attractive things such as individual stocks.
It may be even worth paying taxes in a taxable account to be able to invest in these other options. I would rather have the flexibility of a brokerage account and its investment options than the state tax benefits of a For those without the expertise to pick their own investments, however, the limited options may be acceptable and even preferable.
State plans are literally and figuratively all over the map. The plans may also differ by the kinds of investments you can make, the costs of those investments, minimum contributions and how the plans are administered more generally. The rules on plans are strict. The most important one is this: you must use funds in a account to pay for qualified educational expenses. Qualified education expenses include tuition and fees, room and board as well as textbooks. They may also include other expenses for attending college such as a computer and software used primarily for the classroom.
So this extra withdrawal would incur regular taxes plus the bonus penalty, even though the parent had every intention of using it for qualified expenses. Some lower-income families may be just as well off to save in a regular taxable account as in a plan without the restrictions. College is expensive enough without doing things that minimize the amount of free money that you can receive. And a plan can count against you in the calculations that determine your eligibility for aid.
It could get worse if another relative owns the account , though these rules are in the process of changing.
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