Investment Options for College Savings

Investment Options for College Savings

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Many of us get all sorts of “questions” and “advice” when it comes to what type of investment options to use for college savings….”You haven’t opened a 529 plan yet?” “I heard you’ll get more financial aid if you don’t save for college.”

In this post, continuing with the college savings theme, I will explore the different types of investment options.

Investment vehicles available include:

  • Coverdell Education Savings Accounts (ESAs),
  • U.S. Education Bonds,
  • custodial accounts,
  • 529 plans, and
  • both Traditional and Roth IRAs.

With so many choices, here’s what I believe to be the most beneficial for investors reading this blog.

I will be discussing:

  • 529 plans first,
  • then custodial accounts, and
  • finally, IRAs and Roth IRAs.

I will not be going into detail about specific investment choices for saving for college.  Since college savings often begins as a long term investment but always ends as a short term investment, it is generally prudent to use less aggressive investment strategies when saving for college.

529 Plans:

First, here are the basic attributes of 529 plans:

  • Contributions are made with after-tax dollars.
  • Considered assets of the parent, which for financial aid purposes, does not count as much as assets owned by the child.
  • Two available options: a college savings plan, or a prepaid tuition plan.

College Savings Account:

The first type of 529 plan is the college savings account.  This type of plan is accepted at any accredited college, and has many investment options to choose from.  Earnings and withdrawals are federal income tax free when used for qualified higher education expenses.  In addition, some states offer a state income tax deduction for contributing to your state of residence’s plan.  The account can be transferred to another family member or withdrawn (subject to income tax and 10% penalty) if it is not used for qualified higher education expenses.  College savings accounts have a lifetime contribution limit that varies by state ranging anywhere from $235,000 to over $511,000.  Also, you can contribute 5 years of the gift tax exclusion in one year (up to $70,000/individual or $140,000/married couple) per beneficiary.

Many 529 plans offer age based investment strategies that become more conservative and stable as the child approaches college age.  The quality of investments available and the cost of the plan that may chip away at investment earnings are two major considerations when deciding on a 529 plan.

Prepaid Tuition Plans:

Like the name suggests, the prepaid tuition plan allows the investor to “pre-pay” tuition at the current average rate.  If the student attends a non-participating college, most plans will allow you to roll the account into another, or take a refund (tax consequences will depend on a case-by-case basis).  If the student does not attend college, the plan is normally transferrable to another family member.

Generally, prepaid tuition plans do not cover other expenses, like room and board, just tuition and possibly related fees.  Another consideration is that most state prepaid tuition plans have residency requirements (for either the parent or the child).  They also might have other ristrictions like age or grade limits for students.

When choosing a 529 plan, it is important to note that no two are alike and widely vary by state.  Therefore, it is important to consider what type of plan best suits your needs and make sure to get copies of plan documents to help aid in your decision.

Custodial Accounts:

Next, let’s talk about two types of custodial accounts, Uniform Gifts to Minors Act (“UGMA”) and Uniform Transfers to Minors Act (“UTMA”).   Both are custodial accounts that hold assets for the minor until he or she reaches the age of majority (usually age 18 or 21 depending on the state).  One difference between the accounts is that UGMA law is more limiting as to type of investment (bank deposits, mutual funds and insurance policies).  Both are considered assets of the child and income earned over $1,050 (in 2016) is subject to income tax.  The advantage with these type of accounts is that they are flexible.  The custodian decides how to invest, and the funds can be used for any type of expense (pre-college education, college, other).

IRAs and Roth IRAs:

Now most of you might be thinking IRAs and Roth IRAs are for retirement purposes, and you would be correct.  However, they can also be used to pay for qualified college expenses.  If you withdraw from a traditional IRA, you will pay income tax on the withdrawals, but you should be able to get the 10% penalty waived (with some limitations).

Principal can always be drawn from a Roth IRA tax and penalty free. In general, to avoid a 10% penalty on earnings, the owner must hold the account for 5 years and be 59 ½ when withdrawals begin. However, if used for qualified higher education expenses, the penalty is waived.

Both IRAs and Roth IRAs have an annual contribution limit of $5,500 ($6,500 if 50 or older).  In addition, there are income phase-outs for direct contributions to a Roth IRA.  Here is the link to the IRS chart explaining Roth IRA contributions: Roth IRA contribution amounts


When asked about which type of investment option to use for college savings, more often than not, the solution is a variety of different accounts.  A combination of a 529 plan and a smaller amount in a custodial account that can be used for expenses other than college might be the right solution for your needs.  A Roth IRA is a great way to save for retirement in general, so maybe if it is an affordable option, you open one.  That way, if needed for higher education expenses, it’s an available option.  With so much information in this post, remember to think about what works best for your particular situation.

General links to check-out:

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