Retirement And Tuition: Navigating Dual Financial Goals

Investing for retirement and children's tuition can be a tricky balancing act. It's natural to want to give your children the best start in life, but it's important to remember that you can't borrow to fund your retirement, so this should be your priority.

There are various investment accounts available to help you save for your children's future, each with its own advantages and tax implications. Here are some of the most popular options:

- 529 College Saving Plans: These plans are specifically designed for saving for college and offer tax benefits, such as tax-free withdrawals for qualified education expenses.

- Coverdell Education Savings Accounts: Similar to 529 plans, these accounts offer tax-free growth and withdrawals for qualifying education expenses, with a maximum contribution of $2,000 per year.

- Custodial Roth IRA: This is an option for children with earned income from a part-time job. As a parent, you can manage the account until your child reaches 18 or 21 (depending on your state). Contributions grow tax-free, and your child can use them for major expenses or qualified education expenses.

- UGMA/UTMA Custodial Accounts: These accounts offer flexibility as the funds can be used for anything, not just education. A parent or relative can open and manage the account until the child reaches adulthood.

- Brokerage Account: You can open a brokerage account in your own name and involve your children in investing, giving them a sense of ownership without handing them full control of the funds.

Remember, it's important to have clear financial goals and understand the rules and regulations of each account before investing.

Start a college fund for your child early

The cost of college is on the rise, and starting a college fund while your child is young gives you a good amount of time to create a solid nest egg for their future. Here are some options for how to do that:

529 plans

The name of this plan comes from an IRS code section specifically allowing adults to save for college in the name of a child. The plan has tax benefits; the investment earnings from the account grow free of federal taxes if used for qualifying college expenses. The person funding the account pays taxes on the money before it’s contributed to the 529 plan. States sponsor 529 plans that may also have tax advantages for state residents. These accounts can be opened to benefit a student who isn't the donor’s child, and unused funds can be designated for another student at a later time.

Coverdell Education Savings Accounts

The Coverdell educational savings account is a tax-advantaged way to contribute up to $2,000 a year to a child’s account. This account isn't available to everyone because you need to be under a certain income level to contribute. The advantage is that funds grow free of federal taxes. Sometimes there are state tax advantages.

UGMA accounts

The Uniform Gift to Minors Act is a custodial account, which means your child or the minor for whom you create the account can own investments like stocks and mutual funds. This account gives them the assets but allows the custodian to control them until the minor reaches legal age. This isn't considered a traditional college fund because the money doesn’t grow tax-free. Also, it counts against the student and parent when applying for college financial aid, thus reducing the amount of financial aid that the school may offer your child.

IRA accounts

Most people associate an individual retirement account with retirement savings. However, you can also use an IRA for qualified college payments as long as the contributions have been made for at least five years. IRA plans can be either traditional or Roth, the difference being whether you pay taxes on the funds before or after you put the money into the account. For Roth IRAs, you pay the taxes upfront. Any money taken out within the appropriate timeframe is tax-free. With a traditional IRA, you must pay taxes on the withdrawn money.

Education Savings Account (ESA)

An ESA works a lot like a Roth IRA, except it’s for education expenses. It allows you to invest up to $2,000 (after tax) per year, per child. Plus, it grows tax-free! So, if you start saving $2,000 a year when your child is born, by the time they turn 18, you’d have invested $36,000.

Custodial account

This is an account that an adult controls for a minor. The money added to the account can't be taken out and goes to the child when they come of age (it depends on the state, but usually age 18 or 21).

Savings account

For many parents considering how to start a college fund for their child, the first step may be a savings account at a local bank. It’s an easy way to put money aside for the future. Most banks will let you open a savings account with a small deposit and you can set up automatic transfers from your checking account to keep the fund growing. Interest rates for savings accounts are relatively low, providing about a 2 percent annual percentage yield (APY). There is really no risk of losing your money with a savings account, as long as you choose a bank that’s federally insured.

Choose the best college savings option for you

There are several options for parents and grandparents looking to create a financial pathway for children's college education. Here are some of the most popular ways to save for college:

• 529 Education Savings Plans: These are investment vehicles named after section 529 of the Internal Revenue Code. They allow money to be invested over a period of years and then withdrawn tax-free to pay for tuition, books, supplies, equipment, and, in some cases, room and board for a student studying at an accredited university or vocational school. There are two types of 529 plans: Prepaid tuition plans, where you buy college credits for the future at today’s prices, and education savings accounts, where you build a balance and invest your money in the market. The maximum investment allowed is $18,000 per year per individual (in tax year 2024) and will qualify for the annual gift tax exclusion.
• Coverdell Education Savings Accounts (ESA): Similar to 529 plans, these are investment accounts for your child’s education. Contributions grow tax-free, and withdrawals are also tax-free when used for qualifying education expenses. The maximum investment allowed is $2,000 per year per beneficiary, and there are income restrictions for higher-income households.
• Custodial Roth IRA: If your child has earned income from a part-time job, they may qualify for a custodial Roth IRA. As a custodial account, the parent that opens the account manages the assets until the child reaches 18 (21 in some states). Contributions grow tax-free, and your child can use the contributions for major expenses without having to pay early withdrawal penalties.
• UGMA/UTMA Custodial Accounts: The Uniform Gift to Minors Act and Uniform Transfer to Minors Act (UGMA/UTMA) accounts are types of custodial trust accounts. A parent or relative can open an account on behalf of a child and act as the custodian until the child comes of age. The custodian can make contributions and invest that money in stocks, bonds, or mutual funds to grow the account balance. Withdrawals can be used for education or anything else that benefits the child.
• Brokerage Account: Some brokers offer accounts specifically designed for teens, with minimal fees and a buy-and-hold strategy for long-term investing. Unlike other options, these accounts give ownership to the child, but parents or relatives should monitor activity.

Make sure you're financially stable before investing for your child

It's important to make sure you're financially stable before investing for your child's future. Here are some steps to help you achieve financial stability:

Live Within Your Means

Avoid using credit to fund a lifestyle you can't afford. Keep your standard of living below what your earnings can accommodate. This will ensure you have excess cash flow that can be put toward financial goals or unexpected emergencies.

Set Short-Term Goals

Instead of setting long-term goals, which can seem daunting, set a series of small, short-term goals that are measurable and precise. For example, focus on paying off credit card debt within a year or contributing a set amount each month to a retirement plan. As you achieve these goals, set new ones. This will help you stay motivated and build momentum towards your longer-term financial goals.

Become Financially Literate

Take the time to educate yourself about personal finance and investing. This will enable you to make sound financial and investment decisions and achieve your financial goals.

Save for Retirement

Even if retirement seems far away, start saving now. Compound interest will work in your favor, and building a retirement nest egg becomes more difficult the longer you wait. Consider setting up automatic monthly contributions to a retirement plan, such as an employer-sponsored 401(k) or an individual retirement account (IRA).

Don't Leave Money on the Table

If your company offers a 401(k), contribute at least up to the maximum amount that your employer will match. You can also deduct your contributions to lower your taxable income for the year. If you don't have access to a 401(k), contributing to a traditional IRA will also provide tax benefits.

By following these steps, you can work towards achieving financial stability, which will put you in a better position to invest for your child's future. It's important to remember that investing for your child's education or retirement should not come at the expense of your own financial security.

Consider a 529 plan for tax benefits and flexibility

529 plans are a great option for parents and grandparents looking to create a financial pathway for children. They are investment vehicles named after section 529 of the Internal Revenue Code. They offer tax advantages and flexibility.

Firstly, earnings on a 529 plan grow tax-deferred, and distributions are not subject to federal income taxes. This means that, unlike with other investment vehicles such as mutual funds, you won't pay taxes on a portion of your annual investment earnings or capital gains tax when you withdraw the money.

Secondly, 529 plans offer high contribution limits. While there is no annual contribution limit, each taxpayer can contribute up to $18,000 per year per designated beneficiary. There is a way to get around this limit, however. Donors can front-load contributions for up to five years at once, contributing $85,000 in one year if they don't make any additional contributions for that beneficiary for a five-year period. For married couples, each spouse can contribute up to that amount for a total contribution of $170,000.

Thirdly, 529 plans are flexible. You can change your 529 plan investment options twice per calendar year and roll your funds over into another 529 plan once in a 12-month period. There is no federal limit on the frequency of these changes if you simultaneously replace the account beneficiary with another qualifying family member. You can also use 529 funds for a variety of qualified educational expenses, including tuition, fees, computers, textbooks, and room and board.

Finally, 529 plans are low maintenance. Many plans allow you to automate contributions via payroll deduction or bank account auto-draft, and a third-party company will typically handle the ongoing investment management.

Open a custodial Roth IRA for your child

A custodial Roth IRA is a tax-advantaged retirement account that is owned by a minor but controlled and funded by an adult custodian until the minor reaches legal adulthood. The account offers some flexibility: contributions can be withdrawn tax- and penalty-free at any time.

How to Open a Custodial Roth IRA for Your Child

To open a custodial Roth IRA for your child, you'll need to ensure they have earned income, as this is the main eligibility requirement. Earned income is defined by the IRS as taxable income and wages from a W-2 job or self-employment gigs such as babysitting or dog walking.

Once you've confirmed your child has earned income, you can set up the account online. You'll need to provide Social Security numbers and birthdates for both you and your child, as well as other personal information.

Custodial Roth IRA Rules

There is no age limit for a custodial Roth IRA—even babies can contribute as long as they have earned income. The contribution limit for 2024 is $7,000 or the total of earned income for the year, whichever is less. For example, if your child earns $2,000 from a summer job, you can contribute up to that amount to a Roth IRA in their name.

Benefits of a Custodial Roth IRA for Your Child

There are several benefits to opening a custodial Roth IRA for your child:

• Contributions can be withdrawn at any time without taxes or penalties.
• Your child has more time for their contributions to grow tax-free.
• The tax advantages are ideal for children, as they have a long time horizon and a low tax rate.
• The money can be used for things other than retirement, such as a first-time home purchase or qualified education expenses.

Frequently asked questions