Funding a College Education: Don’t Be Overwhelmed by the Options
New parents focus on milestones such as first steps and first words, not funding a college education. Investing in your child’s college education early in life can pay off in the long run. Each plan has a different menu of benefits and restrictions. It is hard to know if your toddler will grow up wanting to earn a doctorate, go to trade school, or eschew all forms of education. Working with your estate attorney, you can develop a college funding plan that provides the maximum tax-savings and other benefits while still staying within the plan’s restrictions.
Restrictive plans: Cover Qualified Educational Expenses Only
Coverdell education savings account (ESA): A Coverdell ESA covers qualified educational expenses for elementary, secondary, and higher education. Covered expenses are those required to attend a school, such as tuition, fees, books, supplies, and equipment. A limited amount of room and board expenses are covered as well for students enrolled at least half-time. Any higher education program eligible to participate in student aid programs administered by the Department of Education should be covered. 1
Contributions to a Coverdell ESA are made with after-tax dollars and must be made before the beneficiary reaches age 18. When withdrawn, your contributions, as long as they are used for qualified educational expenses and meet other requirements, are tax free. All withdrawals must be completed before the beneficiary reaches the age of 30. As of 2002, the maximum contribution to a Coverdell was increased to $2000 per year. If contributions exceed that amount, a penalty is applied. Coverdell accounts can become very complicated when combined with other savings plans and tax-benefit plans to fund education. However, the right combination of savings plans can make college much more affordable, especially if you start early. 1
529 (Qualified tuition) plans: Like a Coverdell ESA, funds from a 529 plan can be used to pay for qualified educational expenses in K-12, accredited colleges and universities, and apprenticeship programs. Qualified educational expenses are those which are required for enrollment or attendance. For K-12 expenses, there is an annual cap of $10,000. There is no cap for high-education expenses.
States run 529 plans, and therefore the rules for the plans differ between states. The overall goal of a 529 plan is to encourage investors to save for the future by either prepaying tuition or contributing to a savings plan. Prepaid tuition units cannot be used for K-12 educational expenses or future room and board. Prepaid tuition plans are not guaranteed by the federal government and may be guaranteed by the state government.
Money invested in 529 savings plans has the overall risk of investing in mutual funds or exchange-traded funds. Investing in a 529 plan may have tax benefits. Since each state may offer a slightly different 529 plan, and you can potentially invest in any of them regardless of where you live, choosing an option may become quite complicated. 2,3
Health and Education Exclusion Trust (HEET): Funds from a HEET must be paid directly to the educational organization for tuition to be excluded from gift and generation-skipping transfer taxes. Generation skipping transfer taxes are incurred by grandparents who want to leave assets to their grandchildren. A HEET trust can help mitigate this tax burden. A HEET trust requires at least one beneficiary to be a charity, such as a school, charitable organization, or a hospital. HEETs funded during the grandparent’s lifetime are irrevocable and not considered part of the estate. Contributors must have sufficient wealth to contribute funds to the trust that are not required for daily living expenses. 4
Funded educational expenses are your choice
- Revocable Education Trusts and Revocable Living Trusts: As the funder of a revocable trust, you can allocate money and property to pay for any educational expense. You have the power to change the funding limits, change the terms of the trust, change the beneficiaries, and even end the trust entirely. You can determine what education types are funded, what expenses are covered, and how the trust money will be allocated if you have several beneficiaries. This trust’s flexibility comes with the disadvantage that there are generally no income or gift tax benefits associated with setting up the trust.
- Irrevocable Gifting Trust: As opposed to a revocable trust, which allows you full control of how the trust money is spent, an irrevocable trust does not. Giving up some decision-making power can pay off in tax advantages. These trusts can be complicated to structure. An estate attorney can help you determine if, after doing a cost versus benefits analysis, an irrevocable trust is a good option for you.
Options with No Major Restrictions
Uniform Transfers to Minors Act: The Uniform Transfers to Minors Act allows you to set up a custodial account to hold money or funds to benefit a minor. These accounts have no significant restrictions on how the funds are used. The account’s assets are technically owned by the minor, so the custodian is responsible for managing and investing the property, so it benefits the minor. Having the account assets owned by the minor implies that expenses that are considered parental obligations are not paid from this account. Once the minor reaches the age of majority, they have the right to spend the money however they choose, without restrictions.
There are many funding options for education, and they can become quite complicated. Sometimes having many choices is great because each family has unique circumstances and can choose the option that best meets their needs. Sometimes, so many options can be overwhelming. A desire to not make a financial error can lead to avoiding all potentially beneficial funding options. We can help you sort through the options and make the best choice for you and your family.
We Are Here to Help
We are living in uncertain times, but we understand that providing for your family is always a priority. Having a plan in place designed for your family’s unique circumstances can provide substantial peace of mind. We are available to discuss the options available to you and your family as you navigate the current conditions and plan for your family’s education and financial future.
- Saving for College. (n. d.). Intro to ESAs (Coverdell Education Savings Account). Retrieved from savingforcollege.com/intro_to_esas/index.php?esa_faq_category_id=1
- U.S. Securities and Exchange Commission. (2018). An Introduction to 529 Plans. Retrieved from https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html
- Saving for College. (n. d.) What is a 529 plan? Retrieved from https://www.savingforcollege.com/intro-to-529s/what-is-a-529-plan?sfc_wp=true
- Wealth Counsel. (2017). Creating Health and Education Exclusion Trusts (HEET) for your Clients & Their Beneficiaries. Retrieved from http://info.wealthcounsel.com/blog/creating-health-and-education-exclusion-trusts-heet-for-your-clients