QUESTION: Allen wants to know how an Educational Savings Account (ESA) grows – tax free or tax deferred? If his child cannot use all the money in the ESA, what happens to the investment?
ANSWER: It grows tax-free, like a Roth IRA. You’re allowed to put up to $2,000 a year into an ESA if you make less than $200,000 a year.
The money can be transferred to another sibling until he/she is 30 years old. Otherwise, you’ll be taxed heavily on whatever you cash out.
The ESA is the best place to save for your kids’ college education. Even if you get a full-ride scholarship, you’ll still need this money to cover education related things like college living expenses, textbooks, meal plans, etc.
QUESTION: Mandy had $15,000 saved in a mutual fund for her son’s college education. She has some debts she wants to pay off and thought of using that $15,000. Should she do that or will she be robbing from her son? If she keeps saving it, where should she put the money so it will grow?
ANSWER: You should not use this money to pay off your debts. You should move it into a 529 college savings plan. With this, you will be putting a mutual fund into a college savings plan. It will grow tax-free for college. You can set this up through one of our Endorsed Local Providers who will help you put your son’s money in the best type of investment tool.
Normally, you should start college savings with the ESA, Educational Savings Account, but ESAs are only limited to $2,000 a year. In this situation where there’s a much bigger lump sum, you need to start with the 529 so you can dump everything in and continue saving and growing that money.
QUESTION: Joe was completely debt free but has borrowed for his daughter’s education with loans. By the time she’s done, he will have borrowed about $60,000. He makes $100,000 a year. Is it reasonable to have her pay him back? How much should she pay him back?
ANSWER: This is afamily-to-family decision based on what she makes at her first job out of college.
You should bebudgeting money for college out of your income and paying cash for your children’s education – not taking out loans and having your daughter pay you back if she makes enough money.
Don’t go into any more debt to pay for education. Budget some money out of your income, make the other children get part-time jobs and pay cash for college as they go.
QUESTION: A listener wants to set up a college fund for his granddaughter. He wants a fund to which other relatives can contribute with no cap. Does this type of college savings exist?
ANSWER: There’s no such thing. There are three things you can do:
Open a mutual fund in the child’s name. A Uniform Transfer to Minors Act (UTMA) will allow you to open the mutual fund in the child’s name that will be taxed at the child’s rate without a cap. Others can add to this fund as well. The child will get the money when he/she turns 21.
You could also open an Educational Savings Account (ESA) which allows you and other relatives to put in up to $2,000 a year as long as the child’s parents don’t make more than $200,000 each year. The ESA grows tax-free, is very flexible and I’d recommend that you do that with the first $2,000.
The next thing I’d recommend is the 529, which allows you to select and move the mutual funds within the 529. Make sure you get this flexible type of 529. You can contribute up to $10,000 a year or $50,000 as a one-time estate planning contribution.