With the average cost of a 4-year college education in the U.S. now at $145,744 ($36,436 per year) (Hanson, “Average Cost of College & Tuition”, 2023), advanced planning may be more important than ever. Parents have shouldered much of the responsibility of covering these seemingly ever-increasing costs with many opting to pay (via parental loans, income, savings, etc.) for over half of all college expenses for their children. In fact, parental income and savings alone now cover over 44% of college costs. (Hanson, “How Do People Pay for College?”, 2022). In this post, we will examine the various options available to parents (and grandparents) to cover the cost of higher education most effectively.
A multitude of options exist when it comes to saving for college expenses. Some of the more commonly recognized include: Coverdell accounts, 529 plans, custodial accounts, Roth IRAs and savings bonds. Some strategies may be a better fit than others for high-income earning families that are phased out of contributions to certain accounts. The table below summarizes key features of some of the options that might make sense for high-net-worth families including 529 College Savings Plans, UGMA/UTMAs, and direct payment.
College Funding Vehicles
| 529 College Savings Plan | |
|---|---|
|
Contribution Limits |
No annual contribution limit; lifetime contribution limits exist and vary by state |
|
Tax Treatment |
Tax-free growth and withdrawals if used for qualified education expenses; tax on earnings and 10% penalty upon withdrawal if not used for qualified expenses |
|
Gift Tax Rules |
Gift tax applies above annual exclusion amount but can also be “superfunded” with up to 5 years of annual exclusion gifts in one year |
|
Qualified Expenses |
Higher Education: Tuition, room/board, books/supplies, student loan repayments up to a lifetime maximum of $10,000 per borrower* |
|
Ownership & Beneficiaries |
One owner and one beneficiary. Owner has control and makes decisions related to contributions, investments, distributions, and beneficiaries |
|
Inclusion in Estate |
Not included in owner’s estate |
|
*Qualified expenses at the federal level, but state-specific at the state level |
|
| UGMA/UTMA | |
|---|---|
|
Contribution Limits |
No contribution limits exist |
|
Tax Treatment |
Annual income tax responsibility may be either parent or beneficiary depending on income level |
|
Gift Tax Rules |
Gift tax applies above annual exclusion amount |
|
Qualified Expenses |
N/A – funds can be used for anything that benefits the child |
|
Ownership & Beneficiaries |
Irrevocable gift to the child, custodian manages for the benefit of the child |
|
Inclusion in Estate |
Included in custodian’s gross estate until the account becomes property of the beneficiary, then it is included in the beneficiary’s estate |
| Direct Payment | |
|---|---|
|
Contribution Limits |
N/A – expenses are paid at the discretion of the parent/grandparent |
|
Tax Treatment |
Not held in a particular account, income is taxed normally and has no special treatment |
|
Gift Tax Rules |
Direct payment would not be considered a gift for tax purposes |
|
Qualified Expenses |
N/A – funds can be used for anything that benefits the child if the owner pays directly |
|
Ownership & Beneficiaries |
One owner, no beneficiary. No gift is made. Owner has control and makes all decisions with their assets – these are not specifically designated for education.
If assets are given to the child, they become a gift and are subject to gift tax. |
|
Inclusion in Estate |
Included in owner’s estate |
| 529 College Savings Plan | UGMA/UTMA | Direct Payment | |
| Contribution Limits | No annual contribution limit; lifetime contribution limits exist and vary by state | No contribution limits exist | N/A – expenses are paid at the discretion of the parent/grandparent |
| Tax Treatment | Tax-free growth and withdrawals if used for qualified education expenses; tax on earnings and 10% penalty upon withdrawal if not used for qualified expenses Contributions may be deductible at state level | Annual income tax responsibility may be either parent or beneficiary depending on income level Kiddie tax applies above $2,500 in unearned income Contributions are NOT tax deductible | Not held in a particular account, income is taxed normally and has no special treatment |
| Gift Tax Rules | Gift tax applies above annual exclusion amount but can also be “superfunded” with up to 5 years of annual exclusion gifts in one year | Gift tax applies above annual exclusion amount | Direct payment would not be considered a gift for tax purposes |
| Qualified Expenses | Higher Education: Tuition, room/board, books/supplies, student loan repayments up to a lifetime maximum of $10,000 per borrower* K-12 Education only up to $10,000/year* | N/A – funds can be used for anything that benefits the child The account becomes the beneficiary’s property at the age of majority | N/A – funds can be used for anything that benefits the child if the owner pays directly Beneficiary does not receive assets at any time, assets are paid directly to education expenses (cannot go to the child without becoming a gift) |
| Ownership & Beneficiaries | One owner and one beneficiary. Owner has control and makes decisions related to contributions, investments, distributions, and beneficiaries Successor owner can be named, and the beneficiary can be changed to an eligible family member | Irrevocable gift to the child, custodian manages for the benefit of the child | One owner, no beneficiary. No gift is made. Owner has control and makes all decisions with their assets – these are not specifically designated for education. If assets are given to the child, they become a gift and are subject to gift tax. |
| Inclusion in Estate | Not included in owner’s estate | Included in custodian’s gross estate until the account becomes property of the beneficiary, then it is included in the beneficiary’s estate | Included in owner’s estate |
| *Qualified expenses at the federal level, but state-specific at the state level | |||
529 Plans
- 529 account opened for at least 15 years
- Annual rollover cannot exceed annual IRA contribution limits
- Earnings and contributions made in the previous 5 years are not eligible
- Subject to a $35,000 lifetime rollover maximum
This change provides further flexibility for 529 plan funds and makes the vehicle potentially even more attractive. Further IRS guidance is anticipated prior to 2024.
Other College Funding Vehicles
Some additional plans that are commonly used for college savings include Coverdell Education Savings Accounts, Prepaid Tuition Plans, Savings Bonds, and Traditional or Roth IRAs. These have some benefits but may not necessarily be the best fit given a variety of contribution limits and tax consequences.
| Coverdell Education Savings Account (ESA) | |
|---|---|
|
Contribution Limits |
$2,000 per beneficiary (annually)
No contributions allowed after beneficiary reaches age 18 (unless beneficiary has special needs) |
|
Tax Treatment |
Tax-free growth and withdrawals if used for qualified education expense
Tax on earnings and 10% penalty upon withdrawal if not used for qualified expensesContributions are not deductible |
|
Qualified Expenses |
Tuition/expenses; full account must be distributed by age 30 |
|
Ownership & Beneficiaries |
One owner and one beneficiary. Owner has control and makes decisions related to contributions, investments, distributions, and beneficiaries.Beneficiary can be changed if certain requirements are met |
|
Inclusion in Estate |
Generally not included in owner’s estate |
| Prepaid Tuition Plans | |
|---|---|
|
Contribution Limits |
Available to in-state residents, owner purchases “units” or “credits” to effectively lock in the current cost of tuition Plans & maximum contribution limits are state-specific |
|
Tax Treatment |
Tax-free withdrawals if used for qualified expensesContributions are considered gifts, so gift tax may apply for contributions above the annual exclusion amountSome states offer tax-advantaged contributions |
|
Qualified Expenses |
Tuition only (some rare exceptions may apply) |
|
Ownership & Beneficiaries |
Many plans can be transferred to siblings (restrictions may apply) |
|
Inclusion in Estate |
Not included in owner’s estate |
|
Limitations |
These are not available in all states and most plans require residency when you apply for the collegeLimited number of participating institutionsIf unused, most plans will only return your original contribution (potential fees or reductions may apply) |
| Savings Bonds | |
|---|---|
|
Qualified Expenses |
Tuition, fees, books, supplies, and other equipment as well as special needs |
|
Ownership & Beneficiaries |
Owner must be 24 years of age or older to qualify for the interest exclusion |
|
Inclusion in Estate |
Included in owner’s estate |
| Roth & Traditional IRAs | |
|---|---|
|
Tax Treatment |
If withdrawn prior to age 59 ½ for qualified higher education expenses, the 10% early withdrawal penalty will not applyEarnings will still be subject to ordinary income tax upon withdrawal |
|
Qualified Expenses |
Tuition, fees, books, supplies, and other equipment as well as special needs |
|
Ownership & Beneficiaries |
Owner may withdraw to pay qualified educational expenses for self, spouse, children, or grandchildren (who may or may not be beneficiaries) |
|
Inclusion in Estate |
Included in owner’s estate |
| Coverdell Education Savings Account (ESA) | Prepaid Tuition Plans | Savings Bonds | Roth & Traditional IRAs | |
| Contribution Limits | $2,000 per beneficiary (annually) No contributions allowed after beneficiary reaches age 18 (unless beneficiary has special needs) | Available to in-state residents, owner purchases “units” or “credits” to effectively lock in the current cost of tuition Plans & maximum contribution limits are state-specific | ||
| Tax Treatment | Tax-free growth and withdrawals if used for qualified education expenses Tax on earnings and 10% penalty upon withdrawal if not used for qualified expenses Contributions are not deductible | Tax-free withdrawals if used for qualified expenses Contributions are considered gifts, so gift tax may apply for contributions above the annual exclusion amount Some states offer tax-advantaged contributions | If withdrawn prior to age 59 ½ for qualified higher education expenses, the 10% early withdrawal penalty will not apply Earnings will still be subject to ordinary income tax upon withdrawal | |
| Qualified Expenses | Tuition/expenses; full account must be distributed by age 30 | Tuition only (some rare exceptions may apply) | Tuition, fees, books, supplies, and other equipment as well as special needs | Tuition, fees, books, supplies, and other equipment as well as special needs |
| Ownership & Beneficiaries | One owner and one beneficiary. Owner has control and makes decisions related to contributions, investments, distributions, and beneficiaries. Beneficiary can be changed if certain requirements are met | Many plans can be transferred to siblings (restrictions may apply) | Owner must be 24 years of age or older to qualify for the interest exclusion | Owner may withdraw to pay qualified educational expenses for self, spouse, children, or grandchildren (who may or may not be beneficiaries) |
| Inclusion in Estate | Generally not included in owner’s estate | Not included in owner’s estate | Included in owner’s estate | Included in owner’s estate |
With the increasing costs of college education, it is prudent to begin planning and saving early and to take into consideration all relevant financial considerations including estate planning, contribution limits, tax planning, costs covered and flexibility. Working with a team of qualified professionals can often help clarify and simplify this decision-making process.
