Last week we suggested that parents who were prioritizing “saving for college” should put their own retirement, savings, debt, and estate planning needs first.
Assuming they used the past week to accomplish all of those goals, we now turn our (and your) attention to how young parents should set aside money for future higher education expenses.
Again with the Roth IRA
Even if you’re already on track to retire, saving what you can each year in a Roth IRA is usually the shrewdest way to start saving for college.
The contributions can be withdrawn at any time for any reason with no penalty whatsoever. So if you need money to pay for college, you can pull out what you’ve put in to the Roth IRA to cover college costs.
Plus, money held in your Roth IRA will generally not affect any need-based financial aid awarded by a school.
Keep in mind that although withdrawing the Roth IRA contributions is a tax- and penalty-free event, the amount may be included in parental income, which could affect any need-based financial aid your family receives, for the year after the withdrawals are made.
You can contribute the lesser of your earnings, or $5,500 to a Roth IRA ($6,500 if you’re 50 or over). Contributions can also be made on behalf of non-earning spouses, in the same aforementioned amounts.
The 2015 Roth IRA contributions have to be made by your tax filing deadline (not including extensions), which is April 15th of 2016. But you can begin making 2016 Roth IRA contributions right now.
Actually saving for college
Once you’ve taken care of last week’s financial tasks, and fully funded any Roth IRAs, you can start thinking about where your specific college savings money should go.
For most people, the best option is a 529 college savings plan. 529s are established on behalf of most states, and usually managed by mutual fund or financial services companies.
You can use one state’s plan for a kid in another state to attend a school in yet another state. But the plan with the most advantages for Wisconsin residents is the state’s Edvest plan (www.edvest.com).
If you are a Wisconsin resident, annual Edvest contributions of up to $3,100 will provide a dollar-for-dollar reduction in your taxable income at the state level, and can be made for each qualifying beneficiary (such as a child, grandchild, or even yourself).
The value of that tax break of course depends on the amount you deposit, and your state income tax bracket. But contributing the maximum tax-advantaged amount can reduce your state income tax bill by about $50 to $150.
The depositing adult (usually the parent or grandparent) is the owner of the 529 account, and the child or grandchild is the named beneficiary. This feature allows the adult to maintain control of the account, even after the beneficiary becomes an adult.
You can make Edvest contributions for the 2015 tax year no later than April 15th, 2016. Contributions can be as small as $25, or $15 if you set up an automatic deposit plan.
After the deposit
Like most 529 plans, the Edvest account offers several different investment options, kind of like an at-work retirement plan.
You can change your investment allocation twice per calendar year. You can also choose an “age-based” investment option, which starts our more aggressive when the child is younger, and gradually becomes more conservative as the child ages, and is more likely to need the money for higher education expenses.
You can also switch the beneficiary designation among family members. Since there is no “deadline” to withdraw the money, you can also tap unused 529 funds for future generations of the family.
Sure, saving the money for college costs is difficult. But there should be a strategy for withdrawing and spending that money, too. So next week we’ll tell you when and how to tap 529 college savings plans in the future (which will be sooner than you care to imagine).