Investing in potential
Many parents and grandparents start investigating their college savings options before a new addition to the family is even born. Why? Possibly because education is a top priority for their families, and already-expensive tuition increases almost 5 percent every year, according to The College Board. A child born in 2016 can expect to pay anywhere from $94,800 (public) to $323,900 (private) in tuition and fees for a fouryear education in 2034, when he or she turns 18. However, saving toward that goal is much more achievable if you use the tools at your disposal wisely, particularly tax-advantaged college savings vehicles.
Not everyone is in a position to set aside money for the next generation without jeopardizing their own goals, but if you’re fortunate enough to do so or if you can start early and save over time, it is worth looking into your options. Specialized savings accounts, informally referred to as 529s, should be at the top of your list because they offer preferential income and/ or estate tax treatment. In fact, according to Sallie Mae’s “How America Saves for College 2015,” parents with a 529 plan save 89 percent more than those simply using a savings account. Here are a few advantages that parents and grandparents may want to consider.
Capitalize on federal and state tax savings
Assets contributed to a 529 on behalf of your designated beneficiary grow tax-free. Even better? The withdrawals are tax-free as long as they’re used for a qualified education expense, such as tuition, room and board, and supplies, and don’t exceed the actual costs.
Most 529s are state-sponsored, which could provide additional tax savings. For example, some states offer a tax benefit to residents who invest in their state’s plans. Others allow a state income-tax break if you contribute to any state’s plan. It’s important to understand which tax deductions or tax credits may be available — especially if you reside in a state with income tax. Your adviser can help you compare potential deductions.
Take advantage of flexibility
Many people worry that gifting large chunks of money to a 529 means they’ll irrevocably give up control of those assets. Hard to swallow, when you’ve worked hard to build your net worth and can’t predict if you’ll need that money later. The good news is that 529s allow quite a bit of control, especially if you title the account in your name. At any point, you can get your money back. Of course, that means it becomes part of your taxable estate again, subject to your nominal federal tax rate, and you’ll have to pay an additional 10 percent penalty on the earnings portion of the withdrawal if the money isn’t used for your designated beneficiary’s qualified higher education expenses.
What if your beneficiary receives a scholarship or financial aid? Well, you’ve got options here, too:
• First, you can earmark the money for other types of education, like graduate school.
• Second, you can change the beneficiary, as many times as you like, since most 529s have no time limits. You just need to do so before the new recipient actually heads to college. This option is particularly helpful if your designated beneficiary chooses not to go to college at all.
• Third, you can take the money and pay the taxes on any gains. Normally, you’d expect to pay a penalty on the earnings, too. But that’s not the case for scholarships. The penalty is waived on amounts equal to the scholarship as long as they’re withdrawn the same year the scholarship is received. Of course, you can always use the funds to pay for other qualified education expenses, like room and board, books and supplies, too.
Plus, many plans offer you diversified portfolios allocated among stocks, bonds, funds, CDs and money market instruments, as well as agebased portfolios that are more growth-oriented for younger beneficiaries and less aggressive for those nearing college age.
Bypass gift taxes for five years
A grandparent, or anyone really, can contribute up to $14,000 a year per person ($28,000 if married filing jointly, for 2017) with no gift tax consequences. Better yet, if you can swing it, you can “super fund” your 529 using the five-year accelerated gift election, a lump sum gift of $70,000 per contributor ($140,000 for married couples). The catch here is that you can’t make additional gifts for the next five years, but your larger gift now has the opportunity to compound taxfree over a longer time.
Minimize potential estate taxes
Estate tax benefits can be significant, especially if you have a large number of kids or grandkids you want to benefit. Once a 529 plan is funded, it is considered a completed gift to the beneficiary for federal estate tax purposes even though the owner retains full control of the account. It shifts assets out of your estate (unless you make yourself the beneficiary) and can grow tax-free until needed. If opting for a five-year election, the contributor must outlive the election or it will be prorated back on a calendar year basis.
Give generously
Lastly, it doesn’t matter how much you make, you can contribute to a 529 for anyone of any age, including yourself if you plan to go back to school. And lifetime contributions are generous as well. Depending on the state, you can contribute more than $200,000 to help your future learner avoid or minimize student debt.
What about financial aid?
Most Americans supplement their contributions to college expenses with financial aid of some sort, but aren’t quite sure how college savings could affect future aid. There are some things to consider with 529s. You have to decide how to title the account — who will own it and who will be the beneficiary. Is it better to own the 529 plan and make your child or grandchild the beneficiary or to put the 529 plan in the beneficiary’s name outright? Another option for grandparents and aunts and uncles is to contribute to an existing 529, opened and owned by the child’s parents.
Set your course now
Saving for college doesn’t have to be daunting, just disciplined. It helps to take advantage of investment vehicles designed to help you along the journey. Each has its benefits and considerations, so it’s wise to talk to your professional adviser before making a yearslong commitment. For example, 529s, like many other investments, come with fees and are subject to market fluctuations, unless you opt for a prepaid account. And you can only make changes to your asset allocation twice a year.
On the plus side, 529s have higher contribution limits, no income limits and a low impact on financial aid eligibility. They allow for taxand penalty-free withdrawals of principal at any time and for any purpose. The earnings portion, however, must be spent toward qualified higher education expenses. Any leftover funds withdrawn will incur federal income tax and a 10 percent penalty.
Talk to your adviser to see if 529s are the right way for you to give the gift of education — whether it’s for a child, grandchild, family friend or even yourself. Paid advertisement. Sources: The College Board, savingforcollege.com, kitces.com, forbes.com. Earnings in 529 plans are not subject to federal tax and in most cases state tax, as long as you use withdrawals for eligible college expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible higher education expense, you generally will be subject to income tax and an additional 10 percent federal tax penalty on earnings. An investor should consider, before investing, whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Copyright 2017 Raymond James Financial Inc. All rights reserved.