As the cost of higher education continues to rise, paying for school is a significant concern for parents (and grandparents). There are several savings and investment vehicles designed specifically for college funding, including 529 state savings plans, tuition plans, Coverdell education savings accounts, and custodial accounts. Each option offers different advantages and presents potential disadvantages. Norton Financial Consultants can assist you with the option(s) that work best for you and your family.
529 Plans: State Savings Plans
The 529 state savings plan is a tax-advantaged education savings vehicle governed under Section 529 of the Internal Revenue Code (IRC)—hence the name "529" plans. Since their creation in 2001, 529 account monies can be used to pay for graduate or professional school tuition and other qualified higher education expenses, including fees, books, supplies, and equipment, as long as the student attends an eligible educational institution. But now, for the first time, these accounts can be used for primary and secondary education expenses up to $10,000 a year per student. This is a big expansion of the appeal and utility of 529 plans. Previously, investors looking for tax preference on education costs before college had to use other account types such as Coverdell Education Accounts. (Coverdell accounts will remain available, despite speculation they would be curtailed. Those accounts have disadvantages to 529s, though, including much lower contribution limits). The 529 account is now potentially even more compelling than it was before. Contribution limits remain the same, allowing for annual contributions in 2018 of $15,000 for single taxpayers and $30,000 for those married filing jointly. Some taxpayers might consider making five years of contributions ahead of time, amounting to $75,000 for individuals or $150,000 for couples. The details of these plans vary by state, and some states offer tax deductions for contributions.
Prepaid Tuition Plans
Although prepaid tuition plans are similar to state savings plans in that they fall under Section 529 of the IRC, the two plans are different. A prepaid tuition plan is a tax-advantaged college savings vehicle that lets you prepay tuition expenses based on today’s cost and use the funds when your student enrolls.
Prepaid tuition plans can be run by states or colleges. For state-run plans, you prepay tuition; for college-run plans, you prepay tuition at the participating college(s). The details of prepaid tuition plans vary according to state.
Coverdell Education Savings Accounts
A Coverdell education savings account (Coverdell ESA) is a tax-advantaged education savings vehicle that lets you save money for college, as well as for elementary and secondary education (K through 12) at public, private, or religious schools.
A custodial account establishes assets that can be used for the benefit of a minor. The accounts are owned by an adult with the minor as the beneficiary. The assets can be used to pay for higher education or for anything else that benefits the minor (e.g., summer camp, medical or dental expenses, educational programs or lessons, or even a laptop/computer).
Effect on Needs Based Financial Aid
Your decisions on how to save for college expenses impact the financial aid process. When the time comes to apply for financial aid, your family’s income and assets are used in the formula at both the federal and the college (institutional) levels to determine how much money you are expected to contribute to college costs before you receive aid. This number is referred to as the expected family contribution or EFC. (Your eligibility depends on your Expected Family Contribution, your student’s year in school, enrollment status, and the cost of attendance at the school the student will be attending.)
In the federal calculation, your child’s assets are treated differently than your assets. Your dependent child must contribute approximately 20 percent of his or her assets each year, while you must contribute approximately 6 percent of your assets. This formula can dramatically affect the resources you have for higher education.
A custodial account (UTMA or UGMA) is classified as a student asset. In contrast, 529 accounts, Coverdell ESAs, 529 state savings plans, and prepaid plans are considered parental assets (if owned by the parent). Accounts owned by grandparents or other relatives or friends are not part of the formula for needs-based financial aid.
Withdrawals from 529 College Savings Plans and Coverdell ESAs used to pay the beneficiary’s qualified education expenses are not classified as parent or student income on the federal government’s aid form (FAFSA). Withdrawals from prepaid tuition plans are counted as income, and any distributions from a prepaid tuition plan reduce your child’s cost of attendance, potentially reducing the needs-based aid award dollar for dollar.
We Are Here to Assist
Choosing the college savings plan that is right for you and your family can be confusing. Norton Financial has the expertise and experience to guide you and help you determine which savings vehicle(s) best fits your financial situation and your family’s needs.
*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. To be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.