Education is the greatest gift you can give your child or grandchild. Unlike material items, it keeps on giving and directly impacts our personal and professional lives.
If your goal is to help your child or grandchild graduate college with little or no debt, there are a few things you should be aware of.
Understanding Education Planning
The cost of a college education is at an all-time high. Attending a four-year public college costs 179.2% more than just 20 years ago, with the average total yearly cost—including tuition and fees—clocking in at over $36,000.
To prepare for the rising costs of university, it's critical to start planning as soon as possible. Education planning is simply the process of determining the cost of college and creating a plan to pay for the expenses. Remember, tuition is just one piece of the puzzle. You must also factor in living arrangements, loans, scholarships, books, and the cost of living.
Aside from your child not being in substantial debt when they graduate, education planning has many benefits, including:
Compound interest: The earlier you start planning, the sooner you can capitalize on the power of compounding (earning interest on interest).
Preparedness: Life can throw many curveballs, but with an education plan, there's less risk that those curveballs can impact your child's future education.
Good financial habits: An education plan can help instill healthy habits in you and your child. It's an excellent opportunity to teach your child about long-term goals and how to save and invest.
Education planning is ultimately about your child's financial security, and with an intentional plan in place, their future can be brighter than ever.
Types of Education Savings Accounts
There are two main education savings accounts: 529 plans and Coverdell Education Savings Accounts (ESA). Let's break down each plan's benefits, contribution limits, and tax benefits.
529 plans
529 plans are the most popular way to save for your kid's college. A 529 plan is a state-sponsored savings account for education costs. It's similar to a Roth 401k or Roth IRA in that you invest after-tax contributions, so when you take distributions, the funds won't be taxed. You can use the funds to pay for qualified education expenses such as tuition, room and board, and books.
529 plans are beloved for their flexibility. There is no federal limit on the amount you can contribute, contributions grow tax-deferred, withdrawals are tax-free, and they are accessible to many households. There are contribution limits at the state level, but they range from $235,000 to $575,000. For example, the lifetime contribution limit for a 529 plan in New York is $520,000 for all 529 accounts.
Note that while there aren't contribution limits, it's a good rule of thumb not to exceed the $18,000 gift tax limit for 2024, so you don't have to claim the excess as a gift.
It’s also helpful to research which 529 Plan is best for your unique needs. There is no rule that you have to use your state’s 529 Plan – especially if there are other plans available that better meet your needs. However, some states do offer a tax deduction if residents contribute to their 529 Plan, which can be helpful in the long run.
Coverdell Education Savings Accounts (ESA)
A Coverdell ESA is a tax-deferred trust account that helps families pay for education expenses. Earnings within an ESA grow tax-free, and distributions are income-tax-free as long as the funds are used for educational purposes.
Coverdell ESAs are similar to 529 plans but allow more flexibility in using the funds. Tutoring, special needs services, and school supplies are qualified educational expenses. There are some limitations, however, including:
The maximum contribution limit per child per year is $2,000.
Only families with an adjusted gross income of $95,000 or below for single taxpayers and $190,000 or below for married taxpayers can contribute the maximum amount.
Funds must be used when the student reaches 30, or you will face taxes, fees, and withdrawal penalties.
Whatever you choose, the longer your money is invested in these accounts, the more time your funds will have to grow, and the better the tax benefits will be.
Financial Aid Considerations
Financial aid is any college funding that doesn't come from your earnings and can include grants, scholarships, and federal or private loans. Aid can come from various sources, but your child must apply for the Free Application for Federal Student Aid (FAFSA) to be considered for federal aid.
However, will a 529 plan affect how much aid you can get from the FAFSA? Marginally.
When determining aid eligibility, the FAFSA considers income, checking, savings, and brokerage accounts. If a dependent student or their parent owns a 529 plan, it's reported as a parent asset on the FAFSA. However, if the account is owned by anyone else, such as a grandparent, it's not reported as an asset on the FAFSA.
Creating a Customized Education Savings Plan
Setting realistic education savings goals involves understanding the projected education costs, evaluating your family's financial resources, and creating a plan that prioritizes your goals. There are a few best practices to follow when creating a customized education savings plan:
Research the cost of education
Assess your household total income and expenses
Factor in inflation
Explore multiple savings vehicles
Set realistic savings goals that are timely and measurable
Remember that life and financial circumstances change and evolve. Regularly review your savings goals and be prepared to adjust them as needed.
A Financially Stable Future
Education shapes our lives and provides individuals with enormous opportunities both personally and professionally. As a parent or grandparent, you can help shape your child's future with the gift of education, but it's critical to start saving and strategizing as soon as possible. Contact our team to get started on creating an education plan that fits your goals.