We’ll give our children and grandchildren dozens of gifts over their lives, but the most important gift we give may be a contribution to their college education.
Unfortunately, higher education costs continue to increase each year greater than the overall rate of inflation. As a result, developing a sensible strategy to plan, save and invest, and ultimately pay for higher education has become more important than ever.
Fortunately for many individuals and families, there are many options available today to help fund higher education. Here are some of those options; however, we caution that individual circumstances may be different and would recommend meeting with a qualified advisor.
Coverdell Education Savings Accounts:
These accounts have existed for many years and have often been referred to as an "Educational IRA." The maximum annual contribution is limited to $2,000 each year and is non-deductible. Contributions must be deposited before the beneficiary reaches age 18 and used before age 30. Importantly, all contributions are treated as a gift each year and removed from the donor’s estate. Distributions must be used for qualified expenses, such as tuition, fees, books, and supplies. The beneficiary can be changed on the account. Unfortunately, the ability to contribute may be phased out for higher-income taxpayers.
U.S. Savings Bonds:
Savings bonds backed by the full faith and credit of the United States government have long been an effective and simplistic strategy to pay for higher education costs. Savings bonds that are issued after 1989 for certain EE and I series bonds may be redeemed federal tax free if the proceeds are utilized for qualified higher education expenses. Interest income is tax free at the state and local levels. There are no gift tax considerations as the bonds remain the property of the owner and as a result remain in the owner’s estate. In addition, beneficiary considerations are also not relevant. The maximum investment permitted is limited to $10,000 each year per owner and per type of bond.
529 Plans:
A 529 Plan is named for the section of the Internal Revenue Code and offers many features that are unavailable with other funding options. Contributions are non-deductible, however, withdrawn earnings are also excluded from income to the extent the funds are used for qualified higher education purposes. Any income realized is not taxable. Importantly, all contributions are treated as a gift each year and removed from the donor’s estate. These plans also offer the additional benefit of contributing up to five years or $70,000 in contributions to the account immediately. A recent amendment to these plans allows for a change in investments twice a year compared to the earlier option of once per year. The beneficiary can be changed on the account. Finally, there are no time or age restrictions or and income phase out considerations. Simply, 529 Plans provide a lot of flexibility and options.
Uniform Gifts to Minors Act (UGMA) & Uniform Transfers to Minors Act (UTMA):
Accounts established under both UGMA and UTMA have less restrictions and limitations (i.e. qualified educational expenses, maximum investment, etc.) and as a result, offer additional flexibility than other options. Any contributions are treated as a gift each year and removed from the donor’s estate. Importantly, the first $1,000 of unearned income is tax-exempt, however, unearned income over $2,000 for certain children over age 23 is taxed at the parents’ rate. Ultimately, custodianship terminates when the minor reaches the age established under state law, which is generally 18 or 21.
Other:
There are additional strategies that may be used for funding higher education expenses such as Savings Accounts, Roth IRAs, Traditional IRAs, and Taxable Investment Accounts. We would urge caution in terms of utilizing accounts that are established for the purposes of retirement.
Sensible financial and higher education planning will provide a strategy to fund both retirement and higher educations goals and objectives. At the end of the day, an individual may be able to finance higher education, while financing retirement is never an option.
