Education Planning 101

September 23, 2019

Although it’s best to start the college investment process when a child is young, it is never too late to begin. No matter the childs age, what’s important is that you plan now. It is easy to put off thinking about these expenses, hoping that your student will receive scholarships or financial aid. But don’t count on them. While these awards do help with college funding, they are not guaranteed, not always comprehensive and not available in every case.

Section 529 College Savings Plan

Generous contribution limits and potential for tax-free qualified withdrawals make a 529 plan the education savings choice for many families. A parent or grandparent can lump together up to five years of gift tax exclusions ($15,000 for 2019) as a $75,000 one-time contribution ($150,000 for a joint contribution). States also may offer tax breaks on plan contributions. Check out prepaid tuition plans in your state, too – but keep in mind which schools participate in the program.

Note, too, that in late December 2017, new federal tax legislation was signed into effect that changed how 529 accounts can be used. Individual states may have variations. First, tuition for primary and secondary education is now a qualified expense. Other changes include higher gifting limits and tax-free rollovers from 529 accounts to Achieving a Better Life Experience (ABLE) accounts, which can be used for qualified disability expenses.

These changes and enhancements provide increased flexibility around how you can save, and you should consult with your financial advisor to determine whether these strategies may be appropriate for your situation.

Coverdell Education Savings Account

This tax-advantaged account’s main drawback is its modest contribution limit – $2,000 per beneficiary per year. If your modified adjusted gross income is less than $110,000 ($220,000 for married couples filing jointly, with phase-outs above $190,000), you can use contributions to cover qualified higher education expenses or elementary and secondary education expenses. Contributions grow tax-free, and qualified withdrawals are free of tax at the federal level and often at the state level. Any funds left in the Coverdell account must be distributed to the beneficiary when he or she reaches age 30, unless that person has special needs. Also, note that rollovers from a Coverdell account to a 529 plan are considered qualified expenses for the Coverdell account.

ABLE Accounts

The Achieving a Better Life Experience (ABLE) Act of 2014 created the federal framework that allows parents to fund long-term care for a disabled child in a tax-free savings account (similar to a 529 account), for the life of the child.

The funds are held in a way that preserves eligibility for Supplemental Security Income (SSI recipients must have less than $2,000 in assets) and potentially Medicaid assistance. You may already be aware, but these types of means-tested benefits come with tricky rules for eligibility. That's why it’s important to consult your advisor before gifting assets to a person who relies on government benefits.

Preparing to Launch

When it comes to safeguarding the financial foundation you have worked to build, once your student reaches postsecondary school, he or she will have a number of financial pitfalls to avoid, in addition to balancing all that comes along with their new academic and social lives. It’s more important than ever to discuss with your student the dangers of predatory lending, the onslaught of credit cards, how student loans work, the importance of good credit scores and how to budget and save when facing loan obligations, financial aid refunds, room and board, and textbook purchases.

The first step is to make your student aware of all they will be facing. Discuss whether they will work, and if they plan to, why they should open an IRA. Youth is your student’s greatest asset, and it’s wise to start saving early – both for retirement and the inevitable rainy day.

Now is also the time for students to establish their credit and monitor it vigilantly so they can enjoy greater economic freedom down the road. Parents may wish to have access to a child’s bank or credit card account or add them to a parent’s credit card – setting a lower limit for the child to safeguard them from graduating with a large amount of debt.

Financial Freedom

Once your student has nailed the basics of finance, it’s best to gradually increase their financial freedom while they are still in school. Once they leave campus, they will have to face the reality of utilities and rent, along with other major expenses, and it’s best for them to be prepared for how they will handle everything on their own.

The financial decisions students make right out of the gate will have a large impact on their big picture moving forward. The goal is to keep costs to a minimum and remain debt-free throughout school to be best prepared as they begin their professional careers.

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 college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings.

As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds and protection from creditors. The tax implications can vary significantly from state to state.

Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.

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