Every day as I prepare breakfast, and then again at lunchtime, I watch parents drop off and later pick up their preschoolers at a church near our house. The little ones hop and skip to where their friends are playing, even if there is a foot of snow on the ground. They are always happy, and I can’t help but smile or laugh!
This scene also makes me think of their future. What will the little girl in the bright red coat become? Will she travel the world? Perhaps become part of the team that cures cancer? Or how about the small boy that seems just a little shy. Will he become entertainer of the year? Or decide to devote his life to cleaning up our oceans? Or maybe she/he will open a restaurant or become a teacher or farmer or …………………
In mid-March I have been asked to speak to a group of students at a local college. They are either first generation college students or they have a disability and are part of a program to make their college transition easier. What courage it took for these students to take this step! Many of their families sacrificed to make college possible for them and I am sure they feel a responsibility to make the most of it. Every time I meet with college students, and I have been fortunate to be part of programs at campuses across the U.S., I come away excited and confident in our collective future.
If you think about it, what the preschoolers and college students have in common is a future with many, many choices, opportunities, and challenges. Will they make smart decisions? What will they value? Will they not only celebrate their successes, but also withstand their inevitable disappointments? Life is so wonderfully complex!
What can each of us do to model good behavior and sound choices? One way is to set a good example. I owe so much to my parents and the sound financial choices they made. They cared about their family, friends, and community. They lived comfortably, supported causes they believed in, while setting aside funds to reach goals that seem almost impossible today- higher education for all five of their daughters, no debt (including owning their home outright), travel and retirement. All of that on one teacher’s salary!
My parents started to save for my education early in my life. They periodically bought U.S. Savings Bonds for me because that was one of the few options available to them. I used part of that money to buy an open-hole flute in high school and a little more to buy a wedding band for my future husband. The rest went to my education. It wasn’t a huge amount, but it helped supplement my work/study program funds, earnings from my summer job, and a scholarship.
Today there are other options for parents, relatives, or friends that want to save for a child. You can even save for your own education if you want to. There are pros and cons to each method so let’s look at them, one by one. There are two main types of accounts meant for saving for children and for education—taxable and tax-advantaged.
UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Acct) Accounts
These are custodial accounts—owned by a minor but managed by an adult custodian whose name also appears on the account. The custodian makes investment decisions until the minor becomes an adult in the eyes of the law. Upon reaching the age of majority, the age at which a child legally becomes an adult, the ownership of the account is changed to the minor’s name alone. The age of majority varies from state to state. Custodial accounts can be opened at most of the places that you already save or invest. The products or securities that you can purchase are therefore related to where you choose to open the account.
Tax is usually due each year on any income—interest, dividends, and capital gains (profit on securities you have sold)—in this type of account. Although the first roughly $1,000 of income is tax-free, any income over that is taxed at the child’s tax rate. The assets in the account count as the child’s when applying for financial aid so keep that in mind. Funds may be used for any purpose, not just education.
Federal gift tax rules apply to contributions to a UGMA or UTMA account. A donor is assessed and must file a gift tax return if the gift is over a certain dollar limit which changes from year to year. For 2022, the limit is $16,000/per beneficiary/per giver. Therefore, married couples can gift up to $32,000/per beneficiary in 2022 without filing a gift tax return. Although possible, it is highly unlikely that your gift would ever be subject to gift tax as the current lifetime gift and estate tax exemption in over $12 million.
All the tax-advantaged accounts listed have annual contribution limits which vary. However, no tax is due on any income or the appreciation of assets until funds are removed permanently from the account. In some cases, no tax is due at all.
Tax-advantaged education saving accounts house funds intended to cover expenses of education for a specific individual, the account beneficiary. The account owner, who may be the same person as the beneficiary but usually is not, chooses investments and makes account changes. Owners may be parents or grandparents, for example. All the accounts listed have annual contribution limits and federal gift tax rules apply to contributions. (See above.) When money is taken out of the account, the earned income portion of the withdrawal may not be taxed if the funds are used for specific education-related purposes.
529 College Savings Plan (after-tax contributions)
Education savings plans were first created in 1986 when the State of Michigan established a prepaid college tuition plan. Now all 50 states offer 529 College Savings Plans which may be used to invest for and cover qualified education expenses. In 2017, K–12 public, private, and religious school tuition were included as qualified expenses for 529 plans along with post-secondary education costs. Accounts are administered by each state; therefore, rules on contributions and the investment choices vary from state to state.
Typically, a state board selects investments from which an account owner must choose and therefore returns vary. A great website to compare costs and performance of all 529 plans is savingforcollege.com. You may invest in any state’s plan. Some states offer tax deductions or credits to those who contribute to 529 Plans. Some states restrict the tax benefit to residents who invest in their own state’s plan, and some states offer the tax benefit no matter which state’s plan you choose. Since the plans originate from states, no federal income tax is assessed on income.
529 ABLE Accounts (after-tax contributions)
Like a 529 college savings plan, 529 ABLE accounts are savings accounts administered by the states and rules and qualifications are similar. Money can be withdrawn tax-free when the funds are used to pay for qualified disability expenses.
Coverdell Education Savings Account (after-tax contributions)
Coverdell Education Savings Accounts may be used to cover both qualified K–12 and higher education expenses. Beneficiaries must be eighteen years of age or younger when the account is established, and funds must be used by age thirty. High-income individuals may not be able to contribute to this type of account per legislative restriction. The annual maximum contribution is $2,000 per beneficiary from all sources. Accounts may be opened at most financial institutions and the selection of investments is made by the account owner.
U.S. Savings Bonds
United States savings bonds are debt securities issued by the United States Department of the Treasury. Savings bonds are nonmarketable treasury securities issued to the public, which means they cannot be traded on secondary markets or otherwise transferable. They are redeemable only by the original purchaser, or a beneficiary in case of death.
Provided you fall within income parameters, Series EE and I bonds may be purchased and later used for higher education expenses with tax benefit. Provided both principal and interest are used toward education and provided all qualifications are met, owners may exclude all the interest earned from federal income tax which is known as the Tax Free Interest for Education program. (Not all taxpayers may qualify.) Qualified higher education expenses incurred by the taxpayer, taxpayer’s spouse or dependent must be incurred in the same year the bonds are cashed in. Please check online for all the rules, qualifications, and exclusions. Savings bond interest is exempt from state and local taxation.
The rate of interest paid for Series EE and I saving bonds changes periodically. According to the TreasuryDirect website, the current initial interest rate on new Series I savings bonds is 7.12%. You can buy I bonds at that rate through April 2022. Today, Series EE Bonds pay a fixed 0.10% interest.
As you can see, there are options for saving for the education of your children or for you or a friend or relative, should you decide to support their or your own education. If your child receives money gifts at the holidays or for their birthday or other milestone, consider setting a sound financial example and teach them how to save and invest using one of the types of accounts that will eventually benefit them. Your child will have a head start on his or her financial journey!
~Bev Bowers, CFP®