Congratulations!

If you are reading this, that means you are looking to set up your child for the future. It can be a very daunting task, as more often than not, we (as parents) struggle to set ourselves up for our future. On that note - it is VITAL you are currently contributing to a Retirement Plan. Remember, your children can always apply for student loans, but you can’t obtain loans for retirement! You are doing a great service to your family in being proactive and taking action.

There are various ways to plan for your child’s future. The earlier you start, the better! Although the information we cover will be brief, at the very least, it can give you an idea of what options are available. Once you are ready to possibly open an account, shop around with various companies and speak to them about what you are looking to accomplish. I strongly recommend you consult a Financial Advisor or Tax Advisor for more information.

529 Education Savings Plan

What does it do?

Establishes a tax-advantaged education fund with high contribution limits for yourself or someone else. Start an education fund for your children or a family member with a 529 Savings Plan. You can open and contribute to almost any 529 plan, no matter what state you live in and regardless of your age or income. You can make contributions, change investment portfolio selections (twice per calendar year as authorized by the IRS), take withdrawals, and change beneficiaries—as well as perform other account maintenance.

With limited exceptions, you can only withdraw money invested for qualified higher education expenses or tuition for elementary or secondary schools without incurring taxes or penalties.

You will want to ask what fees and commissions are associated with the account.

Are there any state restrictions?

While all states offer some type of 529 plan, there's no requirement that you pick your own state’s plan. It's important to compare plans and make a note of their differences. Some state plans do not currently offer income tax deductions for plan contributions. In this case, other states' plans may have lower costs or more attractive investment features. Please consult your tax advisor for more information on which 529 investment makes the most sense for the state in which you reside.

Keep in mind that your child doesn’t necessarily have to go to school in the same state where his or her plan was established; the full value of the account can be used at any accredited college or university in the U.S. Prior to establishing a plan, ensure you ask if it may restrict using the funds out of the state.

What if my child doesn’t go to college or doesn’t use all the funds?

You can either name a new beneficiary for the account or withdraw the funds. If you name a new beneficiary, he or she must be an eligible family member of the current beneficiary (e.g., a brother, sister, son, or daughter) to keep the tax benefits. Potential gift taxes or federal generation-skipping taxes may also apply.

If you choose to withdraw the funds from the account for nonqualified expenses, the earnings portion of a nonqualified withdrawal is subject to federal and state income tax and a 10% penalty. State tax treatment of earnings may vary. If the beneficiary receives a scholarship for qualified education expenses, dies, or becomes disabled, you may request a penalty-free withdrawal. In these situations, the account may still be taxed on the earnings portion of the withdrawals. Please consult your tax advisor to discuss your individual situation.

How do I invest?

There are multiple investment options based on asset allocation models and are composed of well-known mutual funds from multiple fund families intended to help provide diversification across stocks, bonds, industry segments, and investment styles.

You can choose an age-based option, which automatically adjusts the asset allocation mix as the child nears college age, or you can choose a static portfolio that sticks with a particular investment strategy based on your goals and risk tolerance.

With both of these options, you can select the type of funds—actively managed or index—that best suit your investing style. Choose an actively managed fund portfolio for a professionally managed investment with the potential to outperform the market or select an index fund portfolio for a lower cost approach that tracks market performance.

Will this affect the ability to qualify for financial aid?

Guidance from the U.S. Department of Education says that a 529 plan is counted as an asset of the parent or other account owner in determining eligibility for federal financial aid. Only 5.6% of the value of the account is considered the parent's assets for financial aid calculations. There is no impact if the account is owned by another relative, such as a grandparent, aunt, or uncle. When assets are held in the child's name, such as with a custodial account, only 20% of the assets will be considered. Schwab recommends that you consult your tax advisor concerning your particular situation.

Can I transfer an existing custodial account into a 529 plan?

You may be able to transfer all or part of a custodial account to the 529 College Savings Plan if you are the custodian for a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account. The transaction may be taxable, but any future earnings may grow tax deferred. Because custodial assets are irrevocable gifts, the minor will be the 529 account owner and beneficiary, and you will be the responsible individual on the account. When the minor reaches legal adulthood (the age varies by state, but it's typically age 18), the minor will have full control of the account.

Education Savings Account

What does it do?

Set up a tax-deferred account to pay for educational expenses from kindergarten through college. Ideal as a supplement to a 529 Education Savings Plan, an education savings account (ESA) helps you pay for education expenses from kindergarten through college, and withdrawals are tax-free when used for qualified education expenses. Contribution can be made to an ESA and a 529 plan for the same beneficiary in the same year.

You will want to ask what fees and commissions are associated with the account.

Who manages the account?

You manage the account until it is transferred to your child. To avoid penalties and taxes and preserve the tax-advantaged status, the account must be liquidated when your child is 30 years old or transferred to a qualified family member.

Are there any contribution limits?

Contributions are limited to $2,000 per year until the beneficiary’s 18th birthday. Contributions are not tax-deductible, and income limits apply that may reduce this amount.

Are there withdrawal penalties?

Withdrawals of earnings for nonqualified expenses may be subject to a 10% federal penalty and are considered taxable income. Contributions over the legal maximum of $2,000 are subject to an additional 6% tax for each year the excess remains in the account.

Can a beneficiary have more than one ESA?

Your child may have education savings accounts spread throughout various companies, but total contributions to all ESAs are limited to the $2,000 annual limit.

What if my child doesn’t go to college or doesn’t use all the funds?

If the beneficiary of an ESA decides not to go to college or doesn't need all of the funds, the ESA may be transferred to another member of the beneficiary’s family.

Can I roll over funds from a Traditional or Roth IRA into an ESA?

No. Rollovers into an ESA are not allowed.

Custodial Accounts

What does it do?

Make a financial gift to a minor that may be used for education or other purposes. Allows you to teach them about investing. It is set up and managed by an adult and turned over to the child when he or she reaches the age of majority, typically 18 or 21 (or up to 25), depending on the governing state.

You will want to ask what fees and commissions are associated with the account.

What are the benefits?

No contribution limits
No gift tax incurred for contribution up to $15,000 ($30,000 per couple) for each beneficiary in a single year
Withdrawals can be made at any time and for any purpose, as long as it benefits the beneficiary
Tax-free earnings on the first $1,050
A reduced tax rate on earnings over $1,050

What should I consider?

All assets are held in the child’s name
20% of the assets will be considered when applying for financial aid
A custodial account is an irrevocable gift and must be turned over to the child when he or she reaches the age of majority

Can I use a Custodial Account to set up a college fund?

If your primary goal is to offer funds for college, you may want to consider a 529 College Savings Plan or an Education Savings Account, which have specific tax advantages for saving for college. Talk to your tax advisor to find out what is best for you.

What if I want to transfer a significant amount of wealth to a child?

If that’s your primary goal, you might want to consider opening a trust account, which can offer you more flexibility, control, and protection than any other type of account.

What is the Uniform Gifts to Minors Act?

The Uniform Gifts to Minors Act (UGMA) allows an adult to serve as Custodian and is responsible for investing and managing the assets. This allows the child to own stocks, bonds, mutual funds and other securities. Friends and family can make contributions to the accounts, which carry no contribution or income limits. These deposits are irrevocable and will become permanent transfers to the minor’s account. However, the child is the “beneficial owner,” meaning the assets really belong to the child, not the adult. At age 18, the assets must be turned over to the child.

What is the Uniform Transfers to Minors Act?

The Uniform Transfers to Minors Act (UTMA) allows an adult to serve as Custodian and is responsible for investing and managing the assets. This allows the child to own stocks, bonds, mutual funds and other securities. Unlike an UGMA, this can also include real estate, works of art, and intellectual property. Friends and family can make contributions to the accounts, which carry no contribution or income limits. These deposits are irrevocable and will become permanent transfers to the minor’s account. However, the child is the “beneficial owner,” meaning the assets really belong to the child, not the adult. The UTMA allows for maturity, up to age 25, before it is handed to the beneficiary.

Additional Information

Ways to pay for college that may not benefit you!

Using home equity to pay for college may allow your child to pay for college, but instead of saving for retirement, you will find yourself deeper in debt and closer to retirement.
Using student loans to pay for college. Expenses can add up very quickly and this could result in even more loans! Depending on your child’s major, their income may not be enough to pay off the loans in a timely manner. Many college attendees find themselves paying off student certain amount of money now (normally the current cost of college) and they promise that college will be paid for when your child turns 18. Unfortunately, these programs typically only cover tuition, not room and board which can make up the majority of college costs. There is also no guarantee that your child will be accepted or even want to go to that school. Lastly, if the program does not succeed, the money may just be returned to you.
An Educational Savings Account could prohibit you using various Tax Credits that offer better benefits than the ESA which only allows you to contribute up to $2,000 annually.

Reasons to not save money under your child’s name!

There is little benefit under the current tax law. In the past, parents used to save money in their child’s names to avoid paying more taxes. In 1986, there was a Kiddie Tax created to prevent parents from exploiting a tax loophole. This law establishes various benchmarks that determine the amount of taxes paid. The IRS won’t tax the initial amount (for this example, we will say $1,050). The next amount, say $2,100, will be taxed at a reduced rate as well. Once the second benchmark is exceeded, the tax rates increase significantly.
Kids take legal control of their money at age 18 or 21 (or up to 25). Imagine handing $30,000 to your child and he/she can spend the money for either college, a car, or anything else and you can’t do anything to stop it!
Saving in the child’s name hurts your ability to qualify for financial aid. A family whose child has assets is less likely to qualify for financial aid than a family whose child does not have assets.
Loans are for 10-15 years after school, whether they graduated or not!
College Tuition Prepayment Plans (this is also a form of a 529 Plan) allow you to pay for future college tuition and fees at the current rate. This money may not cover non-tuition educational expenses.

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