Invest Wisely For Your Nephew's College Fund

There are several ways to contribute to your nephew's college fund. One way is to set up a custodial account with a brokerage firm or mutual fund company. You can appoint yourself or the child's parents as the custodian of the account. The custodian can manage the assets in the account and withdraw money for anything that benefits the child until the child reaches the age of majority and takes control of the money. Another option is to open a 529 college savings plan. The money in a 529 plan can be used tax-free for college costs, and you may be able to get a state tax break depending on where you live. Additionally, you can look into setting up a Roth IRA, transfer account, or trust for your nephew.

Setting up a 529 college savings plan

With a 529 plan, you can benefit from tax advantages. There are no income taxes due on earnings while the money stays in the account. Additionally, when you withdraw funds to pay for qualified education expenses, those withdrawals are typically federal income tax-free and may also be exempt from state taxes.

Anyone can open a 529 plan account as long as they are a US resident, over the age of 18, and have a valid Social Security or Tax ID number. You can open an account in your name and change the beneficiary to your nephew after they are born and have a Social Security number. Alternatively, you can wait until your nephew is born and open an account in their name, appointing yourself or their parents as the custodian.

The money in a 529 plan can be used for a wide range of college expenses, including tuition, fees, room and board, transportation, books, and supplies. Additionally, up to $10,000 per year can be spent on tuition for elementary and secondary education.

There are no annual dollar limits on contributions to a 529 plan. However, there may be maximum aggregate contribution limits on the account balance over the life of the account, which vary by state. It's important to be mindful of gift tax rules when contributing large sums. For example, in 2023, individuals could gift up to $17,000 per person without paying gift taxes.

A 529 college savings plan is a powerful tool to help your nephew secure their future education. It offers tax advantages, flexibility in usage, and control over the account. Be sure to research the specific rules and regulations of 529 plans in your state to maximize the benefits of this savings vehicle.

Custodial accounts

A custodial account is a versatile way to help your nephew with his finances. You can set up a custodial account with a brokerage firm or a mutual fund company. You can appoint yourself or someone else, such as your nephew's parents, to be the custodian of the account. The custodian will then manage the assets in the account until your nephew reaches the age of majority (21 in most states, and 18 in a few others) and takes control of the money.

Until your nephew comes of age, the custodian can also withdraw money from the account for anything that benefits him (not just college expenses). If you don't want this responsibility, you can simply be the donor—opening the account, contributing to it, and appointing the parents as custodians.

Any contributions to the custodial account are considered irrevocable gifts to the minor that you cannot take back. Taxes on interest, dividends, and capital gains are the responsibility of the minor or their parents, even before the child reaches the age of majority. If you contribute more than a certain amount to the child's custodial account, you may be subject to gift taxes. For example, in 2011, contributing more than $13,000 would have incurred gift taxes.

A custodial account is a great way to save for your nephew's future and ensure he is taken care of when he becomes an adult.

Life insurance

When it comes to saving for your nephew's college fund, there are a few options to consider, each with its own pros and cons. One option is to set up a 529 college savings plan, which offers tax advantages and the ability to invest in mutual funds. Another option is to investigate life insurance as a way to protect and provide for your nephew's future, including the possibility of using the policy as a college fund. Here are some details on how life insurance can be used as a college investment strategy:

How Permanent Life Insurance Works

Permanent life insurance, such as whole life insurance, universal life insurance, and variable life insurance, includes a savings or investment component that can be used for college expenses. For every dollar paid in premiums, a portion goes towards the death benefit, while another portion is diverted to a separate cash-value account. The money in the cash-value account grows tax-deferred, and loans can be taken out against this balance to cover college costs. However, it's important to note that taking out a loan against the policy will reduce the death benefit if it is not repaid.

Pros of Using Life Insurance for College

One advantage of using life insurance as a college investment is flexibility. If your nephew decides not to attend college, you won't face the same tax penalties as you would with a 529 plan. Additionally, life insurance is not included in financial aid calculations, which could increase the amount of financial aid your nephew is eligible for.

Cons of Using Life Insurance for College

There are also some drawbacks to using life insurance as a college investment. Permanent life insurance policies often come with costly fees, including upfront fees, recurring fees, and insurance charges. These fees can make it difficult for the cash value of the policy to surpass the total amount paid in premiums, especially if the policy is not purchased early enough. Additionally, there is the risk that your nephew won't be approved for coverage due to health issues, and the process of taking out a loan against the policy can be complex and time-consuming.

Things to Consider

While life insurance can be a viable option for saving for your nephew's college fund, it's important to carefully weigh the pros and cons before making a decision. It's also crucial to involve your nephew's parents in the decision-making process and ensure that any college savings plan aligns with their goals and strategies. Consulting a financial professional can help you navigate the complexities and challenges of using life insurance as a college investment and ensure that you make the best choice for your nephew's future.

A Roth IRA

To contribute to a Roth IRA, the account holder must have earned income for the year, but that can include jobs like babysitting. The income can come from part-time jobs or odd jobs, as long as the wages are reasonable.

There are contribution limits for this type of account. In 2024, those who meet income requirements can contribute up to $7,000 across a Roth and a traditional IRA. The exception is individuals who are age 50 or older, who can contribute an additional $1,000 per year in what is known as a “catch-up contribution.”.

Roth IRA withdrawal rules are considerably different from the rules that apply to other retirement accounts. Because Roth IRA accounts are funded with after-tax dollars, account owners can withdraw their contributions (but not their earnings) before the standard retirement age of 59 ½ without paying any taxes or penalties.

However, when used to pay for college, these withdrawals are not exempt from income tax on earnings unless the account owner is age 59 ½ or older. If you take money out of a Roth IRA before you've owned the account for 5 years, you'll owe ordinary income tax on the earnings, plus a 10% penalty tax.

There are some pros and cons to using a Roth IRA to save for your nephew's college fund. Here are some of the advantages:

• Using a Roth IRA for college can reduce reliance on student loans.
• Money invested in a Roth IRA can be invested in stocks, bonds, ETFs, index funds, etc., giving you plenty of options to customize your investment.
• There is no penalty for education-related withdrawals.
• You get tax-free growth.

Some of the disadvantages include:

• Using a Roth IRA cuts into retirement savings.
• Roth IRA accounts can lose money.
• Financial aid could be impacted as distributions from a Roth IRA will count as income on the FAFSA, which may reduce your child’s need-based financial aid eligibility.
• You’ll be subject to income and contribution limits.

Trusts

Revocable Trusts

With a revocable trust, the grantor can change the terms or even dissolve the trust at any time. The primary benefit of a revocable trust is that the assets avoid probate after the grantor's death, leading to a quick distribution of assets to the beneficiaries. The terms of a revocable trust are also kept private. The grantor can act as their own trustee or appoint someone else to the role.

Irrevocable Trusts

An irrevocable trust is difficult, if not impossible, to change or dissolve and typically requires the unanimous consent of all beneficiaries to do so. This type of trust is virtually immune to estate taxes and creditor claims as the grantor permanently gives up control and ownership of the assets and money placed in the trust. Irrevocable trusts can also reduce or eliminate the amount of estate tax owed after the grantor's death.

It is important to note that trust funds must be reported as the beneficiary's asset on the Free Application for Federal Student Aid (FAFSA) and can significantly reduce a student's eligibility for need-based financial aid.

Frequently asked questions