College Savings Alternatives

Most people have heard or invested in small 529 plans for their children's college expenses. most don't know though that there are penalties and ramifications even if you use the money for college such as 10% penalty if not used for college expenses and negative impact on financial aid eligibility.

Here are some alternatives that could help you depending on what youre trying to accomplish.

• Coverdell education savings accounts are more flexible than 529s in that they can be used for K-12 schooling, as well as higher education, But they have income limitations and restrict contribution amounts—up to $2,000 a year from all contributors for a single beneficiary. Also, contributions aren’t allowed after the beneficiary turns 18.

The Coverdell account custodian—usually a parent—controls the account, and the beneficiary may take control at the age of majority (in most places, that’s 18), depending on the plan. Earnings grow tax-free, and there’s no federal tax when you take out money for qualified educational expenses. The account must be closed before the beneficiary turns 30. The money can be moved to a 529 for the same beneficiary, a 529 or Coverdell for a relative, or a regular brokerage account, in which case taxes and perhaps penalties are likely to be owed, unless the beneficiary has special needs.

• Roth IRAs are designed to be retirement-savings vehicles, which means that if the child doesn’t go to college, the account owner can have the flexibility of using the money for retirement. Savers can contribute up to $5,500 a year (or $6,500 if over age 50) to a Roth as long as their incomes are within certain limits, and there is no penalty for withdrawals before age 59½ if the money is used for qualified higher-education expenses. However, the account owner may have to pay income tax on the earnings portion of any withdrawal. Note that the entire withdrawal—principal and earnings—may be considered income for financial-aid purposes and will likely affect your aid application for the following year.

• Cash Value Life Insurance is a type of life insurance policy that pays out upon the policyholder's death, and also accumulates value during the policyholder's lifetime. The policyholder can use the cash value as a tax-sheltered investment (the interest and earnings on the policy are not taxable), as a fund from which to borrow and as a means to pay policy premiums later in life, or they can pass it on to their heirs. 

Cash-value life insurance is designed as a permanent form of life insurance that includes a death benefit component and a savings component. Most cash-value life insurance policies require a fixed level premium payment, a portion of which is applied to insurance costs with the balance deposited into a cash-value account. The cash-value account earns a modest rate of interest which is allowed to accumulate tax-free. 

Owners of a cash-value life insurance policy can benefit from savings that accumulate in the cash-value account. Cash-value savings can be accessed in a number of ways. With some types of policies, the cash value can be withdrawn. Withdrawals are tax-free to the extent they don’t exceed the total amount of premiums deposited into the policy. However, withdrawals can have the effect of decreasing the death benefit amount.

We recommend understanding the different features and benefits of the various education savings options, including contribution amounts, control of decision-making and ownership, tax considerations, flexibility with unused balances and financial-aid considerations