If you have children or grandchildren, then that's all you think about these days…costs for higher education have sky-rocketed in the past few years and are only getting higher.
Parents (and grandparents) need all the help they can get in financing a college education. There are many options available, so it’s important to consider carefully the best way to help pay for a higher education.
If your children or grandchildren are young, establishing a savings plan to meet your financial situation as soon as possible can go a long way to building a college nest-egg.
Let’s Talk About A 529 Plan
A 529 plan is an education savings plan created to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code.
Tax advantages of a 529 plan
Any earnings generated grow federal income tax-free (and may also be eligible for state tax deductions) as long as withdrawals are used for qualified higher education expenses as defined in the Internal Revenue Code.
If you’re a grandparent making a contribution to your grandkids’ 529 education savings plan, that can help them realize their educational and professional goals—and it can help you, too. With a grandparent-owned 529 plan, you control the investments, and distributions for qualified educational expenses are federally tax-free.
Be aware that the impact on financial aid eligibility is expiring and starting in the 2024/2025 school year, qualified distributions from a grandparent-owned 529 account will no longer be reported as untaxed income to the beneficiary. And since the Free Application for Federal Student Aid (FAFSA) uses income from two years prior to determine aid eligibility, grandparent-owned 529 accounts will no longer affect financial aid beginning in 2022.1
Section 529 plans are established by various states and offered to residents of all states. Depending on the laws of your home state, favorable tax treatment may be limited to investments made in a Section 529 plan offered by the state.
There are no age or income restrictions for contributions or beneficiaries. As much as $16,000 ($32,000 for married couples) can be contributed each year without gift-tax consequences as of 2019. A contribution of $16,000 a year or less qualifies for the annual federal gift tax exclusion. And under special rules unique to 529 plans, you can gift a lump sum of up to $80,000 ($160,000 for joint gifts) and avoid federal gift tax, provided you make an election to spread the gift evenly over five years.
Create a plan for each child or grandchild
Every 529 plan requires a named custodian – typically a parent or grandparent – and a named beneficiary, the child. The account owner (i.e. the custodian) controls the account, including investment decisions and the distribution of assets and maintains ownership of the account until the money is withdrawn.
There are no tax consequences if you change the designated beneficiary to another member of the family. For example, you can roll funds from the 529 for one of your children or grandchildren into a sibling’s plan without penalty.
Then There’s a Coverdell Education Savings Account
If your income isn't too high you can contribute up to $2,000 a year to a Coverdell Education Savings Account for each of your children or grandchildren under age 18. All withdrawals (including investment earnings) that are used to pay the child's qualified education expenses are income-tax free. The $2,000 contribution limit is phased out with income between $95,000 and $110,000 (individuals) or between $190,000 and $220,000 (married couples filing jointly).
There are several other possible arrangements depending on your particular financial situation. If you are interested in learning more about funding for college, I have information on my website at https://www.saulsimon.com/education-funding that will shed more light on this matter. Or feel free to call me at 732-623-2070 to have a conversation about college funding. I can help you plan today for your child's or grandchild’s education tomorrow. I look forward to speaking with you.
1 John Hancock Investment Management January 10, 2022
While your money is in the account, no taxes will be due on investment earnings. When you take money out for qualified education expenses,withdrawals are federal income tax-free. If the money is not used for qualified education expenses, federal income taxes may be due on any earnings withdrawn. A 10% federal penalty tax and possibly state or local tax can also be added. Some states offer favorable tax treatment or other benefits to their residents only if they invest in their own state's 529 plan.