An education beyond the secondary level at an accredited institution, especially a college or university.
Most families simply cannot afford to pay the high cost of a college education out of current income. Planning and systematic investment for many years is neccessary. Fortunately, the tax code rewards those who save for college with tax-favored status for various education savings accounts.
A Coverdell Eduation Savings Account allows for tax free growth and withdrawals, but has a contribution limit of $2,000 per year; hardly enough to fund the cost of most colleges. The advantage is that this account can be used for preschool, elementary, and high school as well as higher education.
For many years, UGMA or UTMA accounts were a common choice to fund education. These accounts are used to gift assets to minors, and the funds are owned by the child. The income is taxed to the child, which essentially eliminates taxation in most cases, but this type of account has disadvantages, notably that it can impact the ability of the child to receive financial aid and the child can spend the money on unintended or frivolous purchases at the young age of 21, and at age 18 in some States. The donor has no legal right to prevent this.
The most common education account used today is the 529 plan; a municipal security issued by each of the fifty states. Each state selects one or more fund managers, and each state charges a fee to the account holder. The funds grow tax free and are withdrawn tax free if used for a qualified higher education expense, and the funds have a low impact upon financial aid. The contribution limits are very high. We select 529 plans based upon the manager used and the fee charged. The client’s state of residence can be a factor as well, as in some states with an income tax, the 529 plan contributions to that state’s plan are tax deductible.