An educational savings account can be a great way to save for your child’s education. This can be a traditional kids’ savings account, whereby you as his or her parents can open up a savings account in your child’s name, and he or she can deposit money into the account (such as allowance, from gifts, or even earned money), as a means to save for college and other needs. Creating a specialized child saving plan is best to start early so the amount grows but can be done in a number of ways.
Oftentimes, banks will give children slightly higher interest rates on these accounts, and they will usually waive minimum balance or other fees. There are some caveats with these accounts, though. That is, your child may not be able to make frequent withdrawals from this account, and interest rates can be relatively low. Oftentimes, the tax on the interest earned needs to be reported to the IRS.
The Coverdell Education Savings Account
The Coverdell Education Savings Account, or ESA, has a $2000 limit annually per beneficiary. However, distributions are tax free, as long as the money is used for specific purposes as designated by the ESA. Withdrawals that are made in excess of ESA limitations must report these as excess withdrawals on current income tax year returns, paying a penalty of 10% on that money. When those holding these accounts reached the age of 30, they must withdraw the money within 30 days, and pay income tax on the interest generated.
A 529 Plan For College Education
The 529 College Savings Plan is a plan whereby you can save for your child’s college education with fewer tax difficulties. You can open a 529 account with any mutual fund company, and the money he deposits into that account can grow tax-deferred, similar to an IRA. In addition, in contrast to the ESA (Educational Savings Account), contributions can be up to $11,000 per person instead of the $2000 as limited by the ESA, and there are no income restrictions when it comes to contributions for the 529 plan.
529 plans, however, can ONLY be used for college expenses, not educational expenses prior to college. As with the ESA, qualified withdrawals are tax free, but unqualified withdrawals are subject to a 10% tax penalty, just as with the ESA.
Finally, ownership is also different between the Coverdell Educational Savings Account and the 529 plan. With the educational savings account, the child is actually the owner, but the 529 plan account is owned by the person who actually opened that account. This could be a difficult, depending on what happens when the child reaches college age and begins to apply for financial aid.
The biggest deciding factor as to whether you should open an educational savings account or a 529 plan is what the expected annual contributions for each plan will be. If contributions are expected to be less than $2000 from all sources, then an educational savings plan is likely to be a good idea. If contributions are expected to exceed $10,000 from all sources, then a 529 plan is probably a better bet.
A Standard Kids Savings Account
Finally, getting back to a simple savings account that is in your child’s name, this is also a good way to save for college, but the interest may be taxable. Nonetheless, it’s a much more “fluid” way to save money for your child, in that it can be used for a variety of purposes, and not just to cover the cost of a college education. The final choice is up to you, and of course it also depends on what your child’s own goals are going to be in the end. Because with an ESA you can pay for some elementary and high school expenses as applicable, this may be a much more flexible option if you do intend to have your child go to private school whereby these expenses will be a factor even before college. And of course, if your child opts not to go to college at all, the 529 plan can have some limitations, in that it can only be used for college expenses (if there is to be no penalty for withdrawals) and must be withdrawn in full by the age of 30 regardless. This can result in penalties that can be somewhat expensive, and in this case, it may be better to go with a simple savings account and/or an educational savings account.