College Saving: Alternatives to the 529

In prior articles, I touted 529 plans as the premier college savings tool.  However, there are other alternatives to consider – depending on your risk tolerance and goals.  Savings bonds, Coverdell Education Savings Accounts, and Roth IRAs accounts are just a few of the available alternatives to 529 plans.

 

1.     Savings Bonds

Series EE and Series I bonds are particularly popular for people who consider themselves risk averse.  Backed by the federal government, the bonds range in value from $25 to $10,000.  Series EE bonds previously could be purchased at half the face value in paper form, but now the US Treasury only allows electronic purchases from TreasuryDirect at face value.  If you redeem the bond to pay for college expenses and want to exclude the bond’s earnings from federal income tax, income restrictions apply.  In 2016, single filers had a $92,550 income limit, while married couples filing jointly had a $146,300 income limit for the tax write-off.  Series EE bonds purchased on or after May 2005 earn a fixed interest rate, currently set at 0.10% through October 31, 2017. 

Series I bonds are a little more flexible.  You can purchase Series I bonds electronically through TreasuryDirect (up to $10,000 annually) OR in paper form with your federal tax refund (up to $5,000 annually).  Interest on Series I bonds consists of a known fixed interest rate when you buy the bonds plus an inflation rate calculated twice annually by the Treasury.  Consult this guide for a complete list of the similarities and differences between Series EE and I bonds.

2.     Coverdell ESAs

If you want to take a little more risk than government-backed Series EE and I bonds, Coverdell Education Savings Accounts, or ESAs, should be considered.  You can contribute up to $2,000 annually per year per beneficiary to an ESA so long as your income level is below the threshold.  Single filers must have modified adjusted gross income (MAGI) below $110k, and married couples filing jointly must be below $220,000.  Although contributions are not tax-deductible, earnings grow tax-free. 

Coverdell ESAs offer an attractive advantage to families sending their children to private grade school and/or high school: funds may be withdrawn without penalty for any K to grade 12 expenses in addition to college.  Another bonus?  You can withdraw funds from the Coverdell for your college student and maintain eligibility for the American Opportunity and Lifetime Learning credit if not using the same qualified education expenses.  In other words, the IRS doesn’t want you to “double dip” when claiming the tax credit and withdrawing from your Coverdell account.

3.     Roth IRAs

Most of you have likely heard of a Roth IRA as a retirement planning tool.  The maximum contribution is $5,500 annually for owners under age 50.  For owners age 50 and over, the annual contribution limit in 2017 is increased to $6,500.  Again, you need to be careful with income levels to contribute.  Partial contributions are allowed for married couples earning $186,000 or over, and you are completely phased out at $196,000.  Partial contributions for single filers begin at $118,000 and phase out completely at the $133,000 income level.  “Back-door” Roth IRA conversions are a popular option for people above these thresholds.

Earnings in a Roth IRA grow tax-free even though you don’t receive a tax break on contributions.  You are always able to withdraw the exact amount of Roth IRA contributions without penalty.  However, withdrawing earnings could subject you to a penalty if you don’t meet one of the exceptions.  Here are some of the examples where you can withdraw earnings and avoid the 10% penalty:

a.     Owners age 59 ½ or older with a Roth IRA open at least five years

b.     Qualified first-time home purchase

c.     Death or disability

d.     Qualified higher education expenses for you, your spouse, children, and even grandchildren

Both Coverdell ESAs and Roth IRAs allow you to select the underlying investments for your account.  This can be wonderful if you like to control the investment options and are well-informed of the underlying risks and potential rewards for an asset class.  However, some people prefer just a few investment options, or they hire an advisor to assist with investment selection.

 

529 Plans: The Gold Standard

Within the confines of this article, it is difficult to provide every nuance about savings bonds, Coverdell ESAs, and Roth IRAs.  I encourage you to click on each of the above-referenced website links for more detailed information and conduct independent research.

Despite college savings alternatives, I still feel that 529 plans are the gold standard.  There are no income restrictions for contributions, assets grow tax-deferred, and assets can be withdrawn tax-free for qualified higher education expenses.  If you have a sudden wealth event, you can put much more money into a 529 plan in a single calendar year than any other alternative described in this article ($70k per beneficiary in 2017 for single account owners).

Please share this article with friends and colleagues if you found it helpful!  And let me know if you have any further questions about the college planning landscape.  September is life insurance awareness month, so expect my next blog posts to be focused on that topic.

Forever Faithful,

Deborah Meyer, CPA/PFS, CFP®