Creative Funding Considerations for Education Can Help Even Before CollegeRead Time 5 min

Education funding is one of the largest expenditures most American families will undertake, and costs continue to grow, far outpacing inflation. Today, average costs for just tuition and fees, not including room and board, exceed $36,880 per year for private schools, and $10,440 for in-state residents (or $26,820 for out-of-state residents) attending public schools.

Funding four years of college, or potentially more, requires forethought, and savvy families need to consider how they will pay for post-secondary education. The best chance we see for a successfully executed savings plan includes getting started well in advance and harmoniously incorporating the right mix of strategies.

Setting up college savings accounts to benefit a child can be done in several ways, the most common being 529 savings plans. Named for Internal Revenue Service Code 26 U.S.C. § 529, these tuition plans are sponsored by states or educational institutions. Custodial accounts, or Uniform Transfers to Minors Act (UTMA) accounts, are also common and offer different benefits.

• 529 Plans: Anyone can open a 529 plan — a parent, grandparent, guardian, aunt, neighbor or friend — but in some states, the account owner may not be entitled to the full tax benefits unless the beneficiary is a dependent. Whoever opens the 529 account is the owner and remains in control of the funds even after a beneficiary reaches the age of majority. The major benefit of a 529 plan is that growth on investments is tax free, with most states offering additional benefits in their plans. An owner can change beneficiaries to another family member of the beneficiary. Funds held in a 529 account may be withdrawn and used for qualified post-secondary education expenses and, with recent tax law changes, K-12 expenses (with limitations), otherwise taxes and penalties may be incurred. It is important to note that, when registered in a parent’s name, 529 plan assets are considered parental assets from a FAFSA (Free Application for Federal Student Aid) perspective.
• UTMA: For UTMAs, the child receives full ownership of the account upon reaching the age of majority. The gains realized within an UTMA may be subject to taxes; so, if not handled thoughtfully, accessing these funds can have the potential to be expensive. At the same time, one major benefit is that funds from UTMA accounts can be used more flexibly for non-educational expenses.

The total amount contributed to a 529 plan for each beneficiary is defined by the plan; each state has a set cap. In addition to the total allowable contribution, most states limit the state tax benefits. For example, an account owner who lives in the state of Wisconsin can take a state tax deduction of $3,340 per beneficiary per year. Those who contribute more can carry forward the amount to future years. Some states allow significantly more or may allow a state tax deduction for contributions to another state’s plan.

The Tax Cuts and Jobs Act, passed in late 2017 and effective starting in 2018, includes a provision allowing families to use 529 plans for up to $10,000 of K-12 expenses. It is important to understand how each state handles these types of withdrawals to ensure that distributions for these purposes do not cause adverse outcomes (such as a recapture of previous state tax deductions). Families considering using 529 plans for primary or secondary school should also reconsider the time horizon and investment profile of their 529 accounts.

Grandparents who plan to contribute to their grandchildren’s education should keep a few things in mind. Money a child receives from a 529 account registered to a grandparent (or anyone other than their parents) is considered income to the child from a FAFSA perspective and thus counts against financial aid formulas.

To avoid having the benefit of this generous gift offset by the FAFSA reduction, a grandparent can consider several other strategies:

• Encourage grandchildren to use funds from the 529 account in the later years of their education. This will prevent the gift from interfering with factors on which the FAFSA is based.
• Deposit the funds into a Uniform Gifts to Minors (UGMA) account or other account owned by the parent for the benefit of the grandchild.
• Gift the funds to the grandchild’s parents and have the parents make a deposit into a 529 account.

Thoughtful education planning can incorporate a combination of strategies, such as those mentioned here, and can ultimately establish education funding for multiple generations within a family. Successful strategies can also provide gifting and estate planning opportunities for parents and grandparents. Working with your financial advisor, attorney and accountant is the best way to structure a successful education planning strategy that works best given your personal financial situation.