3 ways to save for your child's future

Little girl sitting next to a piggy bank outdoors © iStock

Opening a savings account in a child's name may seem like a great way to give Junior a head start on a lifetime of thrift. However, it can come back to haunt families, especially when college years roll around.

In fact, choosing the wrong savings vehicle for your children's future college cash needs could cost them thousands in avoidable taxes and missed financial aid.

"There is an asset protection allowance, or APA, that protects a portion of the parents' assets, based on the age of the older parent," when determining financial aid, says Mark Kantrowitz, publisher of and author of "Filing the FAFSA."

"Don’t confuse the APA with the IPA. The IPA, or income protection allowance, shelters a portion of income. The parent IPA is based on family size and the number in college, and represents a basic living expense allowance."

Meanwhile, students' income and savings have a bigger, more negative, impact on the availability of financial aid than parental assets and income.

Because financial aid is determined based on income and assets from the year prior to applying for aid -- in most cases, the student's junior year in high school -- students with large amounts of savings in their name could end up losing a hefty sum of free college cash.

Fortunately, there are several ways for parents to save that will not put their child's future financial aid at risk. The following are 3 places to safely stash the cash:

3 ways to save

  • 529 college plans.
  • UGMA and UTMA accounts.
  • Roth IRA.

529 college plans

One popular method is to save for college through a college savings plan.

Operating similar to IRA and 401(k) plans, 529 college savings plans allow parents to save for a child's education tax-free through an array of investment options. Some age-based investment packages place funds in aggressive investments when the child is young, then automatically switch funds to more stable options as the child approaches college age.

These plans offer major tax advantages, says Craig Parkin, managing director at TIAA-CREF Tuition Financing, the investment organization that administers Kentucky's state-sponsored college savings plans.

"The gains on the accounts are tax-deferred, and once the funds are used to pay for qualified tuition expenses, parents will never pay taxes on those funds," he says.

Money in these accounts can be used for undergraduate or graduate studies at any accredited 2- or 4-year campus in the United States. Savings in a 529 plan belong to the parent, not the child.

"A 529 college savings plan is considered a parent's asset because the parent is the account owner and they can change who the beneficiary is," Parkin says.

Kelly Campbell, a Certified Financial Planner professional and founder of Campbell Wealth Management in Alexandria, Virginia, cites another advantage of these plans.

"An additional benefit with a 529 plan is that if the child says they don't want to go to college, the parents or whoever owns the account can change the beneficiary," Campbell says. "That way, you know the money will be used for education. They can't just take it and run."

While 529 savings plans offer big advantages, they also come with a few restrictions. According to the U.S. Securities and Exchange Commission website, 529 college savings funds can be pulled out tax-free only for qualified education expenses, including tuition, books, fees, supplies, and room and board. Money spent on unqualified expenses is subject to income tax and a 10% penalty on earnings.

There are also restrictions on how money in these plans can be invested. For instance, account owners can change the investments in their plan only twice a year.


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