When planning your college investment strategy, one of the important
decisions you will make is choosing the most appropriate type of
investment for your situation.
As you develop your plan to invest for college expenses, here are
some questions to ask yourself and information to help you with the
decision-making process.
Will I use the investments exclusively for college expenses?
If you plan to open an account to use exclusively for college
expenses, a 529 Plan may be your best choice. A 529 Plan offers many
benefits, including withdrawals that are free of federal income tax
and penalty if used to pay for qualified college expenses.*
You may want to consider a Coverdell Education Savings Account (CESA,
formerly the Education IRA) if you also might use the investments
for elementary or secondary school expenses. You can make tax-free
withdrawals from a CESA for elementary, secondary or post-secondary
(college) expenses.
The CESA has a low maximum contribution limit ($2,000 per year)
compared to 529 Plans ($200,000-$300,000 lifetime limit). If you
decide to invest in a CESA, you may want to consider supplementing
it with a 529 Plan. You can contribute to both account types in the
same year for your child, and you'll be able to invest more toward
college and other education needs.
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Do I need an investment account that offers multipurpose uses?
You have a couple of options if you want to invest in an account for
multipurpose uses.
If you open an account under the Uniform Gifts/Transfers to
Minors Act (UGMA/UTMA), the money in the account must be used for
your child's benefit, whether for education or other expenses. The
account will be registered in your child's name with you or another
adult acting as custodian. Your child is the legal owner of the
UGMA/UTMA investments and gains control of the account at a set age
defined by your state (usually 18 or 21).
If you want the investments to be available for miscellaneous
expenses and you want to maintain control of the account, you may
want to consider opening a regular, taxable account in your name.
This option allows you the most freedom with your investments;
however, you lose the tax benefits that the other account options
offer.
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Should I use my traditional or Roth IRA for college expenses?
It's possible to use your traditional or Roth IRA investments for
college expenses; however, this may not be the best option for you.
Remember that investing for your retirement should be your primary
goal when you open a traditional or Roth IRA.
IRA withdrawals for qualified college expenses are penalty free,
but you will more than likely have taxes to pay. With a traditional
IRA, you will be taxed on earnings and any deductible contributions
that are part of your withdrawal. With a Roth IRA, you will be taxed
on earnings unless you are age 59½ or older and the account is at
least five years old.
Traditional and Roth IRAs allow you the benefit of investing for
retirement and college in the same account. But you do not get to
take advantage of the tax-free withdrawals offered by a 529 Plan and
CESA or the tax benefits of UGMA/UTMA accounts, and you lose part of
your retirement investments.
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Which investment account offers me the most tax benefits?
A 529 Plan offers you multiple tax-related benefits.
- You do not have to pay income taxes each year on the earnings
in your account.
- When you make a withdrawal for qualified college expenses, you
do not have to pay federal income tax on your earnings.*
- If you contribute to a 529 Plan offered by your state, you may
be eligible for a tax deduction or other benefit on your state
income taxes.
If you contribute to a CESA, you do not have to pay income taxes
each year on earnings, and you also do not have to pay federal
income tax when making a qualified withdrawal. However,
contributions to a CESA are not tax deductible.
With a UGMA/UTMA account, a portion of the investment earnings
may be exempt from federal income tax and the remainder may be taxed
each year. Depending on the amount of earnings, some may be taxed at
your child's tax rate and some at your rate. Contributions to a
UGMA/UTMA account also are not tax deductible.
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These issues may help you decide which account is best for your
college investments. Talk to your financial advisor or an American
Century Investor Relations Representative if you have more questions
about your individual situation.
*The tax-free treatment for 529 Plans applies to
withdrawals made through the year 2010. This provision may be
extended with further federal legislation.
This information is for educational purposes
only and is not intended as investment or tax advice.
