Saving for College

If you’re a parent or plan to be one, chances are you are considering ways to pay for your child’s college education. You may have a goal of sending them to public or private school, with the hope of helping them graduate college with little, if any debt.

Whether or not your goal is to fully fund your child’s education or to help as best you can, there are some options to consider saving as much as you can to reach or education savings goal.

One option to consider is a 529 college savings plan. 529 plans allow money to be contributed specifically for many of the costs of higher education. Money that goes into the account grows tax-deferred, and money withdrawn for qualified college education expenses (tuition, room & board, books, fees) is tax-free.

Many states sponsor their own college savings plans, and some allow a state tax deduction for contributions. Currently, there are no federal tax deductions allowed for 529 contributions. 529 plans also have no income limits – meaning that regardless of income, anyone can contribute to a 529 plan.

Additionally, 529 plans have very high lifetime contribution limits ranging from about $300,000 to $400,000 in total, depending on the state plan. However, the maximum annual contribution limited is $15,000 which is the annual gift tax exclusion. This amount is $30,000 for couples who file jointly. States may also limit the amount of your state tax deduction on contributions.

There is an exception to the annual limit rule which is exclusive to 529 plans. Individuals can make a 5-year pro rata contribution totaling $75,000 (the $15,000 per year exemption multiplied by 5). For married couples filing jointly, the amount is $150,000 (the $30,000 per year exemption multiplied by 5). These numbers are for 2019 and are usually increased annually.

529 plans allow only one beneficiary per 529 plan. The beneficiary may be changed at any time. For example, parents with two children may own one 529 plan with the oldest child named as beneficiary, and then simply change beneficiaries to the younger child when the oldest graduates. Parent can also own one 529 plan for each child. If you’re not a parent yet but want to get started, you can open a 529 plan, name yourself beneficiary, and then simply change the beneficiary to your child when he or she is born.

The money in your 529 plan can be invested according to your risk tolerance or timeline. Many plans have predetermined portfolios of stock and bond mutual funds based on your child’s age, or they allow you to choose your own allocation based on the funds available.

If the money in a 529 plan is used for non-qualified education expenses the earnings become taxable at your ordinary income tax rates and are also subject to a 10% penalty. States may also recapture any tax deductions taken on contributions.

Exceptions to the 10% penalty include if the beneficiary dies, becomes disabled, or receives a scholarship. It’s important to note that in these exceptions, only the 10% penalty is waived. The earnings are still taxable when withdrawn.

Finally, when the time comes to apply for financial aid (grants or student loans) you will likely find yourself filling out the Free Application for Federal Student Aid (FAFSA®). This form essentially determines how much you can contribute toward the costs of college by determining your expected family contribution. 529 plans are considered an asset of the parent (assuming the parent owns it) and the percentage for inclusion in the expected family contribution is much less than assets owned by your child.