Thinking about kids? Or what if you already have them? For those thinking about their kids’ future education, the IRS allows parents to open up an account that’s specific to saving for kids’ education. In Virginia where I live, it’s specifically called the Virginia College Savings Plan.
These are tax-beneficial accounts that grow over time to save up for a kid’s schooling. I know, I know. Some of you are thinking “I have my 401(k), my Roth IRA, and other accounts to max out already.” This is for your kids!
Currently the contribution limit for the Virginia college savings plan is $15,000 per year. If you have 2 kids, you can contribute $15,000 to each kid.
BUT each kid can receive no more than $15,000 per year.
Alternatively, you can front-load 5 years worth of contributions into a Virginia college savings plan.
Yes, you heard that right.
So now go and take that extra $75,000 you have laying around and drop it into your kids Virginia college savings plan.
There is a huge benefit to this since being invested in the market longer generally pays off higher returns and dividend payments. So in this case, each of the 2 kids above can be front-loaded $75,000 each. Some states may have different restrictions for these types of contribution limits so be sure to check with your state.
Right now, there are currently two types of plans:
Prepaid Tuition Plans
The prepaid tuition plans are exactly as it sounds. The parent can pre-pay a child’s future tuition expenses now. These are different from the Virginia college savings plan where you’re investing money instead of pre-paying expenses.
Of course tuition isn’t cheap so parents have a choice of whether they want to do one lump-sum payment or through some sort of installment plan.
Prepaid plans usually only cover the costs for in-state colleges and universities. Some may even cover graduate school. These plans usually cover between one to five years of tuition.
The price of these plans depend of the type of contract, the child’s age, and costs of the tuition. The great thing is that even if tuition prices skyrocket, you’ll already be locked in at today’s tuition costs.
But what if my kid doesn’t go to college?
So what if your kid doesn’t want to go to college? Or what if your kid goes to a college that isn’t covered by the prepaid plan? Do you lose everything?
Fortunately, you may transfer prepaid plans to other beneficiaries. If the kid has siblings, parents can transfer the plan over to them, assuming they’re under the age limit.
Additionally, parents may change beneficiaries of the plan once per year as long as it’s a family member.
In the worst-case scenario, the parents can cancel the plan and have their original investment returned to them. They will lose in on the interest gained tho. In some cases, parents will pay a cancellation fee too.
Virginia College Savings Plans
The second type of plan is a college savings plan. Where I live we call it the Virginia 529 College Savings Plan.
This account is similar to a 401(k) in some aspects. First, you open up an account and you fund it with money from your pocket, with after-tax dollars. However, the assets in this account will grow on a tax-deferred basis. When you withdraw your money, you might have to taxes on the gains. Luckily most gains are not subject to federal taxes, only state taxes.
But even better: if you’re using the money to pay for qualified expenses, then you won’t pay any taxes at all. Qualified expenses include items such as on-campus housing, books, supplies, and fees. Be sure to check the laws with your state for specifics.
Unlike prepaid plains, Virginia college savings plans are self-managed and self-directed. This means you’ll have to decide in what to invest.
Luckily, there are many mutual fund options and investment advisers to assist in this. One of the popular options is a target-date fund. Similar to target date funds in retirement accounts, these funds will automatically re-balance its allocations depending on how close the child is to going to college.
Virginia College Savings Plans for Elementary School
In addition to college savings, the IRS also allows parents to use their Virginia college savings plans to pay for K-12. This includes private schools, boarding schools, religious schools. However, the limit is that parents may only take out $10,000 per year to pay for these costs.
I will personally choose the Virginia College Savings Plan over the prepaid plan. I will bear all the risk but the savings plan allows for more flexibility. Who knows where my kids will end up wanting to go to school. It’s possible they might even want to travel internationally. I think the mutual funds will allow the plan to be fully diversified and grow as the kids age.
Open up a Virginia college savings plan or a prepaid plan here at https://www.virginia529.com/. These plans are usually directly sold or sold through a financial adviser. Direct plans have usually less fees than an adviser-based plan but the owner will have to know what they’re doing.