Saving for College

As we turn the calendar on the lazy days of summer and begin a new academic year, families with college-aged children face the burden of college tuition. According to the Education Data Initiative, the average cost of college tuition and fees at public four-year institutions has risen 179.2% over the last two decades. Moreover, private nonprofit institutions continue to cost more than public colleges. Given this backdrop, you may be considering helping a family member(s) with college savings to ease the financial stress and minimize their potential college debt. This is substantiated if your retirement savings are secure and you plan to leave a large inheritance to your family.

Assisting with tuition has mutual benefits; in easing your family’s financial burden you can build an educational legacy as well as take advantage of tax and estate planning incentives. Here are a few examples:

• An individual can make a gift of up to $18,000 in 2024 to another individual without federal gift tax liability (aka federal gift tax exclusion). This amount is up $1,000 from last year’s limit since the gift tax is adjusted annually for inflation. For married couples, the combined 2024 limit is $36,000. There is no limit on the number of individuals who can receive gifts from someone. Once those gifts are made, the money is removed from the individual’s taxable estate. The annual federal gift tax exclusion means that your eligible gifts do not affect your lifetime exclusion amount. The lifetime gift tax exemption is the amount of money or assets the government permits you to give away over the course of your lifetime without having to pay the federal gift tax. This limit is adjusted each year.

• Tuition payments made directly to the educational institution (domestic or foreign) are not considered gifts for tax purposes and are not counted toward the $18,000 annual gift tax exclusion amount. By paying a school directly, an individual can potentially move a significant amount from their taxable estate. The tuition gift tax exclusion only applies to tuition payments. Money that is gifted to a child for other college expenses, such as books, supplies, room and board costs, do not qualify for the exclusion.

• If the children are young, it may make sense to set up a 529 savings plan for a particular child (the beneficiary) because growth and withdrawals are tax-free when used for education. While these plans are primarily used for college, up to $10,000 per year may be used toward K-12 education for the beneficiary. It is worth noting that post high school expenses at trade schools also qualify, similar to college expenses.

• There is also the technique called “superfunding” that allows a person to contribute a tax-free gift of up to $90,000 (five years’ worth of annual gifts) into a 529 plan. For married couples, this equates to $180,000 per beneficiary. For tax purposes, with an election being made on the gift tax return, the total is spread over the five years to adhere to the $18,000 annual threshold. Like the federal gift tax exclusion, there is no limit on the number of individual “superfunding” gifts that can be made. As such, front-loading a college savings account(s) can minimize your estate while shielding your lifetime estate tax and gift tax exemption.

It is important to note that non-parent owned 529 college savings plans are no longer reported on the Free Application for Federal Student Aid (FAFSA) form and will not impact financial aid. Conversely, the CSS profile, an online application used by colleges and scholarship programs to award non-federal institutional aid, does consider them. Roughly 250 mostly private colleges use the CSS profile to award their institutional aid. Mefa.org is a great resource for college savings information.

Despite the soaring costs of higher education, there are instances where money in a 529 may go unused. For example, the beneficiary receives a scholarship or some other financial aid, attends a more affordable school, or decides not to attend college. With recent legislative changes, distributions from 529 accounts can now be used to give the same beneficiaries a retirement boost as well. So long as the account has been open for 15 years and the beneficiary has earned income, leftover 529 funds can be transferred to a Roth IRA tax and penalty-free up to a lifetime limit of $35,000. Since the contribution limit is indexed for inflation ($7,000 in 2024), this strategy would take multiple years to fully transfer the remaining 529 plan assets up to $35,000.

529 college saving plan aside, you can open a Roth IRA for a teen-aged child that has a summer or after-school job earning taxable income. This tax-advantaged retirement account is managed by an adult (the custodian) and then transferred to the child at a certain age (typically between 18 and 25). Each year, you can contribute up to 100% of the child's income, to a maximum of $7,000 for 2024. Time is on the child's side - a little saved today has a lifetime to potentially grow free of federal taxes in the Roth IRA. Once the account has been opened for five years, the money can then be withdrawn free from federal income tax and penalties as long as the account owner is age 59 ½. Contributions can be withdrawn at any time without taxes or penalties. It is important that the child knows that this is for retirement later and that there are penalties if it is used before age 59 ½. There is an exception to the 10% penalty fee if they withdraw to pay for qualified higher education expenses before age 59 ½.

Contributing to a family member’s college savings or retirement requires open and honest communication with everyone involved. Above all, consider your overall financial plan and prioritize your own expenses first before assisting others with education or retirement expenses. As always, please reach out to your Relationship Manager for additional guidance or to answer any questions.