It’s not always easy to plan for large expenses. Paying for college expenses is certainly one of them. Unfortunately, college tuition and fees have risen quicker than the average rate of inflation.
Between 2006-2007 and 2016-2017 (over a 10 year period) a public 4 year college’s in-state tuition and fees increased on average by about 3.5% per year beyond inflation1. It may not sound like much, but it is significant if we consider that the median family income in the U.S. grew an average of 0.4% per year (after adjusting for inflation) between 2005 and 20152.
Although there are various tax-advantaged accounts that can help save for college expenses, the most popular are 529 plans (also known as qualified tuition programs). 529 plans were created in 1996 specifically to help pay for higher education expenses. There are two different types of 529 plans, college saving plans and prepaid tuition plans. Prepaid tuition plans are not offered in California and contributions into a California 529 Plan offer no tax incentives for CA residents (unlike some states that do) so it makes sense to choose a 529 plan based on its own merit.
Unlike UTMA/UGMA (Uniform Transfers/Gifts to Minors Act) accounts, 529 plans are not subject to the annual kiddie tax and offer tax free growth if used for qualified higher education expenses. Qualified expenses amongst other things include tuition, fees, books and room and board. 529 plans also allow the owner to keep control over the assets whereas UTMA/UGMA accounts eventually transfers the control to the beneficiary at the age of majority (18 or 21 depending on state). In addition, UTMA/UGMA account assets are irrevocable gifts made to the child and are not transferable while assets in a 529 plan are transferrable to another qualifying family member.
UTMA/UGMA accounts on the other hand, do offer more investment options and assets can be used for the child’s benefit; not limited to paying for higher education expenses. If funds are withdrawn from a 529 plan for non-qualifying expenses, the portion of earnings (not principal) will incur a 10% penalty and will also be subject to federal and state taxes.
College students seeking financial aid through grants, work-study, loans or applying for scholarships will need to complete a FASFA (Free Application for Federal Student Aid) application form. Assets in a 529 plan whether student or parent owned are not counted as the student’s assets but rather the parent’s assets in the Expected Family Contribution (EFC) calculation. Student’s assets represent 20% in the EFC calculation, however, parent assets represent a maximum of 5.64%.3 Dividends and interest from a 529 plan are also not reported as the child’s income which is normally assessed at 50% of the EFC. If the 529 is owned by a non-parent such as grandparents, withdrawals from the 529 plan are considered as the child’s income which could count against the student’s EFC the following year.3 One way to work around this is to use the 529 plan owned by the non-parent during the beneficiary’s junior year in college (assuming 4 years of college). Starting in 2017, students are able to submit a FASFA earlier (October 1st rather than January 1st of the following year) therefore report earlier income information.4
To take advantage of compounding growth it is better to start investing in a college savings plan sooner rather than later. For those who want to make a large initial contribution into a 529 plan, a lump-sum 5 year equivalent gift can be made to any single beneficiary. In 2017, a single donor can make up to a $70,000 contribution or a married couple can make a combined gift totaling up to $140,000 without having it count against their lifetime gift exclusion ($14,000 annual gift exclusion x 5 years = $70,000 x 2 = $140,000). This gift assumes that no other gifts are made over the 5 year period to the beneficiary.
Each 529 plan has lifetime maximum contributions. Investments within a 529 plan can be changed twice a year and can be rolled over into a different 529 plan once every 12 months. Depending upon gifting strategy, a Form 709 may need to be filed with your taxes.
Feel free to reach out to your primary relationship manager at OPCM to further discuss plans on funding your family’s education goals.
For more details regarding qualified tuition programs, go to Publication 970 on the IRS website at https://www.irs.gov/publications/p970/ch08.html.
1.&2. https://trends.collegeboard.org/college-pricing/figures-tables/average-rates-growth-published-charges-decade#Key Points
3. http://www.savingforcollege.com/intro_to_529s/does-a-529-plan-affect-financial-aid.php
4. https://studentaid.ed.gov/sa/about/announcements/fafsa-changes
