Taking time now to make sure you’re optimizing funding sources and savings vehicles in your education savings plans will be time well spent. Below, we cover three options to help save for college expenses.
Section 529 plans are a great way to fund education for your children, grandchildren, or other loved ones, given their flexibility in up-front contributions and their tax-advantaged status. These plans are offered by states, some state agencies, and certain educational institutions, but you do not have to be a resident to invest in a particular state’s 529 plan.
Within 529 Plan accounts, earnings on investments and eventual withdrawals are free of income taxes, and in some states contributions to a 529 plan can be at least partially tax deductible (but not for those of us in California). But there are caveats:
Qualified tuition, or 529 plans offer some attractive flexibility, in that you can change beneficiaries (with some restrictions) and/or set up multiple plans for a single beneficiary. They do not impose income limits on contributions or restrictions on which colleges and universities the funds are used for (as long as the institution is accredited). There are also no requirements to use funds in a specific state’s plan to pay for education at a school in that state.
Lastly, 529 plans can be an efficient way to quickly transfer wealth from your estate. While states and individual plans can set overall contribution limits, individuals are allowed to contribute up to the annual gift tax exclusion amount each year or make accelerated contributions by combining up to five years of gifts into a single year. (Note: In 2019, the gift tax exclusion amount is $15,000 per beneficiary from each individual giver, so couples can contribute $30,000 to an individual beneficiary or an accelerated five years’ worth of $150,000.) If you do make accelerated contributions, consult with your tax advisor on how to represent these gifts for tax reporting.
Additional information and resources on Section 529 plans can be found here.
Many families decide to set up a UTMA, or custodial account, for a portion of college expenses. These accounts offer some flexibility, in that the assets can be used toward any expense relevant to the beneficiary (including education costs or other expenses), and you can invest the assets in the account in the way you would with any other brokerage account.
Disadvantages to custodial accounts include the fact that they can only be used for the minor beneficiary designated on the account—they cannot be transferred to another beneficiary. In addition, earnings in the accounts do get taxed (mostly at the child’s income tax rate), and when the minor beneficiary reaches the “age of majority” (usually 18 or 21), these accounts are converted to their personal ownership and control. You need to weigh the pros and cons of these accounts to determine the best role they can play in your college savings plan.
Gifting funds into an irrevocable trust is another way to save for college expenses. The trustee can then direct funds to educational costs, and the assets in the trust don’t have to transfer in ownership to the beneficiary. A trust also offers the flexibility for any funds not used toward education costs to be applied toward other expenses for the beneficiary, such as a down payment for a house or a wedding. There are drawbacks of irrevocable trusts, including setup costs, trustee administration, and separate annual income tax filings. But in certain cases, irrevocable trusts are a great option for families planning for college expenses.
Saving for college is one of the common planning topics we discuss with our clients, and what we’ve covered in this post are just a few ideas to get you started. In our work with families, we begin with a review of funding scenarios, assess pros and cons of different savings vehicles, determine and implement an appropriate investing strategy, then assist with account gifts and transfers.
Because of the complexity involved, and the reality that every family’s education planning situation is different, we recommend working with your Wealth Advisor to put together a customized strategy, and consult with a tax professional along the way, so you can come up with a plan tailored to your family’s specific circumstances.
Do you have questions or want to discuss education savings strategies? Please call your Litman Gregory Wealth Advisor or contact us here.
Research Team Changes
We are pleased to announce that 23-year veteran Jack Chee has taken on the U.S. CIO – Asset Management role.
Insight Newsletter—Summer 2023
Our Insight Newsletter is now available. Included in this edition: Investment Commentary Gauging the Odds of a Recession Wealth Management Team Updates View
Gauging the Odds of a Recession and What it Would Mean for Investors
While the U.S. economy has recently been more resilient than many expected, the question remains whether the Fed’s aggressive series of rate rises will lead to a recession in coming quarters. In this post we consider the relevant economic data to address this question and the potential impact on financial markets.