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The Gift That lasts a Lifetime… Education

December 14, 2021
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It’s that wonderful time of year again when we look to share with others, especially our loved ones. As parents and grandparents, we want our children to have the best opportunities in life and one way to do this is by providing an excellent education. But planning for education expenses, especially four years of college costs, can be daunting. The cost of tuition has increased significantly over the last 40 years, even after adjusting for inflation. From 1989-2016, college costs increased more than 8x faster than wages.[1] A 529 account is one of the tools available to help plan for those future education expenses. 

What is a 529 account?

Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged vehicle which allows you to invest for future education expenses. The earnings in the account grow tax-deferred similar to an IRA. Withdrawals are exempt from federal and, in most cases, state income taxes if the funds are used for qualified education expenses such as tuition, fees, room and board. 529 plan assets are kept outside of the owner’s estate and are not required to change ownership at a certain age. While withdrawals are only to be used for qualified education expenses, it does offer the owner the ability to change the beneficiary if someone opts not to use the funds. The definition for qualified expenses now includes tuition for K-12 schools, but these are limited to $10,000 per beneficiary per year. Tax treatment will vary by state.[2]

When Should I Start?

Anyone can create a 529 plan for a designated beneficiary. Annual contribution limits apply and are treated as gifts, qualifying for the annual per-beneficiary gift tax exclusion. In 2021, the gift tax exclusion is $15,000 per person or $30,000 per couple. A unique feature of the 529 is the ability to front load the contributions, allowing the donor to contribute up to 5 years of contributions in the first year to maximize the time for the funds to grow. Individuals may contribute as much as $75,000 ($150,000 for couples) to a 529 plan in 2021 without incurring a gift tax.[3] Parents and grandparents may consider this as an estate planning strategy to shelter assets from estate taxes while retaining control of the funds in the account. The quickly approaching deadline for 2021 contributions is December 31st

Impact on Financial Aid

Financial aid forms consider 20% of assets held in a child’s name to be available for education expenses.  But a 529 is not considered the child’s asset, so if a grandparent or non-relative owns the 529, the account won’t factor into the financial aid calculations. However, the distributions are included on the FAFSA (Free Application for Federal Student Aid) form 2 years after withdrawal which could impact future financial aid. One strategy a grandparent could consider is saving the 529 distributions until the 3rd and 4th year of college to avoid any negative impact to aid.  Scholarships come with their own set of rules and certain states have tax advantages that others do not. There are a number of complexities with 529 accounts but when used properly, can be a very powerful asset for your family.

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[1] https://educationdata.org/average-cost-of-college
[2] https://www.morganstanley.com/articles/529-plans-a-powerful-tool-to-save-for-college-expenses
[3] https://www.schwab.com/resource-center/insights/content/saving-for-college-529-college-savings-plans