Saving for Education

Next to retirement, education is the most popular savings goal. If you are investing to pay for tuition, consider accounts that offer tax breaks. Two popular education accounts with such tax advantages are the Education Savings Account (also called a Coverdell account) and the UGMA/UTMA account (named for the Uniform Gifts to Minors and Uniform Transfers to Minors Acts). Both types of accounts provide tax benefits to help your savings grow faster.

Compare your options

The choice of which type of account is best for you may depend, in part, on how much you plan to invest and how you’ll be making contributions — all at once or over time. Another important consideration is how much control you think you need over how account dollars are spent. For example, according to IRS rules, money from an Education Savings Account must be used for educational expenses. But that’s not the case for assets held in UGMA/UTMA accounts.

You don’t have to be a parent to contribute

Grandparents, aunts, uncles and even nonfamily members can fund an Education Savings Account or UGMA/UTMA account on behalf of a child. Before funding an Education Savings Account, check with the child’s parent or guardian to make sure the gift will not exceed the total $2,000 annual limit from all contributors.

Make sure you consider the impact of financial aid

Money held in an Education Savings Account or UGMA/UTMA account may influence a student’s chances to qualify for need-based financial aid or the amount of aid awarded. If you are a nonparent donor to either of these accounts, be sure to discuss your contributions with the family first.

Education Savings Account (ESA)UGMA/UTMA Account
How can the money be usedTo pay for elementary and secondary school expenses (kindergarten through grade 12), as well as college expenses.Must be used for the benefit of the child. Once the child reaches the custody termination age (usually 18 or 21, but varies by state), he/she has control over the account.
Maximum contribution per yearTotal combined contribution from all sources must be no more than $2,000.Each contributor may invest up to $16,000 (for a single return) or $32,000 (joint return) before triggering the federal gift tax.
Who may contributeAnyone can contribute on behalf of a child until he/she reaches age 18.

Income restrictions of contributors: Currently, to be able to make the full contribution, your modified adjusted gross income must be less than $95,000 (single return) or $190,000 (joint return). See IRS Publication 970 for more information.
Anyone can contribute on behalf of a child until he/she reaches the custody termination age (usually 18 or 21, but varies by state).
Tax benefitsSavings compound tax-deferred and withdrawals are tax-free when used to pay for eligible education expenses. Contributions are not deductible.For children under age 19, the first $1,150 per year of investment earnings is tax-free; the next $1,150 is taxed at the child’s tax rate; and the remainder is taxed at the parent’s rate. Contributions are not deductible.
ConsiderationsThe total contribution of $2,000 a year may not be enough to pay for your child’s educational needs.
If you are the “responsible individual” (typically the parent or guardian), you may change the beneficiary to another family member (under age 30) without penalty.

Withdrawals for unqualified educational expenses are subject to income tax and a 10% penalty. Generally, money must be withdrawn before the student reaches age 30 or a 10% penalty will apply.
Contributions are an irrevocable gift to the child. You cannot change the beneficiary.

The child has control over the account with no restrictions on how the money can be spent once he/she reaches the custody termination age. Thus, parents concerned that their adult children may not make the best spending decisions may not find this account an appropriate choice.
For information specific to your tax situation, consult a tax professional.

Using retirement accounts for educational expenses

The primary purpose of an Individual Retirement Account (IRA) is to accumulate savings for retirement. However, a parent can tap his or her IRA before reaching age 59 ½ and avoid the 10 percent early- withdrawal penalty under certain circumstances. If your IRA distribution is used for qualifying higher education expenses — such as
tuition, fees, books and supplies for a qualifying family member — it is not subject to the 10 percent premature distribution penalty.

Investing for education with Homestead Funds is easy

Invest for the future of a child with a Homestead Funds Education Savings Account or UGMA/UTMA account. It’s never too soon to get started. The earlier you begin, the more time your money has to benefit from the power of compounding.

If you open an account with Homestead Funds, our Automatic Investing Program allows you to start investing right away with no minimum amount required. You choose an amount and it’s deducted automatically — directly from your paycheck or bank account — as often as you like, such as monthly, quarterly or every payday. 

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