A Guide to the Children Education Savings Plan

Shawn Plummer

CEO, The Annuity Expert

What is a Children Education Savings Plan? In this guide, we will discuss ways to pay for college and how it can help you provide a kid’s college fund in the future. We’ll also talk about what kind of plans are available to new parents looking to save in a college fund for babies. If you’re considering saving for your children’s educational needs, be sure not to miss this guide!

Cost of Going to College

College costs are increasing. According to the College Savings Plans Network, the costs go up by two times the rate of inflation each year. Here’s what you can expect:

Current AgeIn-State PublicOut-of-State PublicPrivate
16$115,563$201,324$264,524
14$129,847$226,207$297,219
12$145,896$254,166$333,955
10$163,928$285,581$375,232
8$184,190$320,879$421,611
6$206,956$360,540$473,722
4$232,536$405,103$532,274
2$261,277$455,173$598,063
Fours Years of tuition, fees, room and board at a 6% increase rate.

529 Plans

If you want to save for your child’s or grandchild’s college education, one way to do it is by investing in a tax-smart investment. These plans and accounts will help you save a lot of money while keeping the money safe from the IRS.

A 529 plan is a tax-advantaged educational savings program for people who want to save for their child’s college expenses.

The contributions that you make with after-tax money are limited. You may contribute up to a specified yearly limit each year, which is $16,000 in 2022.

If you withdraw money from a 529 plan, the funds are entirely federally tax-free (most states provide tax-free withdrawals, too) as long as they are used for qualified education costs.

Types of 529 Plans

There are two types of 529 plans:

  • College Savings Plans: These plans function similarly to other investment programs such as 401(k)s and individual retirement accounts (IRAs), in that your contributions are invested in mutual funds or other investment products. Account earnings are based on the market performance of the underlying investments, and most plans provide age-based investment choices that become more conservative as the beneficiary approaches college age.
  • Prepaid Tuition Plans: Although they are not tax-advantaged, prepaid tuition plans (also known as guaranteed savings plans) enable families to guarantee today’s tuition rate by prepaying for it. When the beneficiary enrolls in college, the program pays out at the future cost to any of the state’s eligible institutions. You can either transfer the account’s value or receive a refund if the beneficiary attends an out-of-state or private institution. Prepaid tuition plans may be offered by states and higher education institutions, although only a few have done so thus far.

529 Plan Cons

Although the 529 Plan has tax advantages, there are penalties for withdrawing funds for a non-eligible college expense or for claiming non-education-related tax credits. The 529 Plan may be subject to the fluctuations that occur in the stock market, meaning there is greater financial risk.

The SECURE ACT

The Setting Every Community Up for Retirement Enhancement (SECURE) Act allows 529 plan funds to be used to pay off up to $10,000 in student loans and registered apprenticeship programs.

Traditional and Roth IRAs

Before you reach age 59 1/2, parents and grandparents can withdraw funds from your traditional or Roth IRA without paying the additional 10% tax to pay for qualified higher education costs for yourself, your spouse, or your children or grandchildren in the year the withdrawal is made. The exemption applies only to the 10% penalty, not ordinary income taxes.

Cons

  • IRA distributions can be counted as income on the following year’s financial aid application, which can affect eligibility for need-based financial aid.
  • IRAs may be subject to the fluctuations that occur in the stock market, meaning there is greater financial risk.

Coverdell Education Savings Account 

A Coverdell Education Savings Account (ESA) may be established at a bank or brokerage firm to assist pay for your child’s or grandchild’s qualified education costs. Coverdell ESAs, like 529 plans, allow money to grow tax-deferred and are tax-free when used for qualifying educational expenses at the federal level.

Cons

  • You will be charged tax and a 10% penalty on earnings if the cash is spent on nonqualified activities.
  • Coverdells may be subject to the fluctuations that occur in the stock market, meaning there is greater financial risk.
  • Coverdell ESA contributions are not tax-deductible. You need to make the contributions before the child is 18 years old unless they have a disability.
  • The maximum contribution per beneficiary per year is limited to $2,000.

Children’s Education Savings Plan With Life Insurance

A policy that provides parents’ life insurance coverage for a specified period of time chosen by you – between 10 and 20 years. At the end of that term, you’ll receive a guaranteed payout for your child. You can use the money to cover your child’s college expenses or anything else that your child needs on his or her path to financial independence.

If you die before the policy matures, the full benefit amount will be paid to your child or other beneficiaries.

The money in your College Plan insurance policy will compound over time, thanks to each premium payment. When you’ve made all premium payments, and the coverage term has ended, you’ll get a guaranteed payout – which could go a long way toward assisting your kid in paying off his or her college debt.

See Gerber Life Insurance.

Pros

Cons

  • The earning potential is less than a 529 Plan, but there is a guaranteed payout to offset this limited growth.

Deferred Annuities

Deferred annuities are long-term savings accounts that grow tax-deferred. Some plans include sign-on bonuses for premiums contributed through the years along with principal protection (fixed and fixed index annuities).

Pros

  • No contributions limits.
  • Only the interest earned is taxed once withdrawals are made. Roth IRA annuity withdrawals are tax-free (if IRS rules are followed).
  • Principal protection on most plans
  • Guaranteed payouts
  • More upside than life insurance.

Cons

  • Parents and grandparents must be age 59.5 to avoid early withdrawal penalties (10% of withdrawal plus income tax). A 72q distribution could be a way around the penalty.
  • Long-term plans

Other Methods of Funding College

Bank Savings Account

This is a traditional method for growing your child’s savings through regular deposits. Remember that interest rates on these accounts are very low, so it will be hard to build wealth beyond what you contribute. Also, the interest earned on bank savings accounts is taxable.

Stocks and Mutual Funds

These investments are more aggressive ways for growing your child’s college savings. They can increase in value quickly but are subject to changes in the stock market, and there is no guarantee of a payout.

Custodial Accounts

A UGMA account and a UTMA account allow you to put money and/or assets in trust for your child or grandchild who is a minor. The trustee (you) manages the account until the child reaches the age of adulthood. At that point, they own the account and can use it anyway they want.

Children’s Education Savings Plan Quotes

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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