Planning for Education

Tuition costs have risen dramatically over the last 30 years, so parents and grandparents need all the help they can get in financing a college education. There are many options available, including 529 plans and Coverdell accounts, as well as other strategies, so it’s important to consider carefully the appropriate way to help pay for higher education. If your child or grandchild is young, establishing a savings plan as soon as possible can put time on your side, but be open to consider alternatives to a traditional savings account.

A 529 plan is an education savings plan designed 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.
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. Be aware that any earnings withdrawn that are not used for such expenses are subject to federal income tax and may be subject to a 10% additional tax, as well as applicable state and local income taxes.

Contribution limits
There are no age or income restrictions for contributions or beneficiaries. As much as $15,000 ($30,000 for married couples) can be contributed each year without gift-tax consequences as of 2019. A contribution of $15,000 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 $75,000 ($150,000 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including investment decisions and the distribution of assets and maintains ownership of the account until the money is withdrawn. Each 529 plan account has one designated beneficiary. A designated beneficiary is usually the student or future student for whom the plan is intended to provide benefits. The beneficiary is generally not limited to attending schools in the state that sponsors their 529 plan.
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.

If your income isn't too high you can contribute up to $2000 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 $2000 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).

Setting up a custodial account in your child's or grandchild's name with a mutual fund company and making regular contributions to that account can help you towards reaching your child's college funding goals. Custodial accounts have significant legal and tax implications. For one there is the "kiddie tax," which taxes the investment income of children over $1900 at their parent's top federal income-tax rate if the child is under age 18 and the child's earned income does not exceed one-half of the child's own support for the year, or, a full-time student who was under age 24 at the end of the tax year and the child's earned income does not exceed one half of the child's own support for the year (excluding scholarships).

Many states and individual colleges offer tuition prepayment plans. With these plans, you make a series of payments or pay a lump sum now for your child's education. In return, the plan guarantees that your investment will cover the child's expenses when he or she is ready to attend. Some plans lock in the cost of future education at today's prices. Before choosing this route, though, be sure to find out what will happen to your investment if your child doesn't attend the sponsoring college.

If your child will be starting college within the next couple of years or has already started, there are still financing methods available for you to consider.
Financial Aid
Most schools have a limited pool of funds, so you should file financial aid forms as soon as possible. Generally, the school will calculate how much aid your child will receive based on your financial situation. Also, your child should apply for all available governmental or private grants and scholarships.
Loans
Your child's aid package may include loans from the federal or state government, the college or a commercial lender. The loan offers may vary considerably, depending on the program, so be sure to carefully check the interest rates and terms of each. Home equity loans, retirement plan withdrawals, and the cash value of your life insurance are other possible loan sources you might consider.
Tax Incentives
If you do take out a qualified higher education loan, up to $2,500 of the interest paid is tax deductible. (Certain restrictions may apply.) You also may be eligible for the American Opportunity Tax Credit and the Lifetime Learning Credit. The American Opportunity Tax Credit is worth up to $2,500 a year for each student's years of eligible post-secondary education expenses. The Lifetime Learning Credit is available for up to $2,000 of qualifying expenses paid for each year of education. Both of these credits are phased out at higher income levels, however.