Strategic Options for Education Savings

August 31, 2023

One of the best gifts you can give your children or your grandchildren is to plan ahead to help reduce their student debt burden in college and beyond. Nearly 44 million Americans have student loans valued at more than $1.57 trillion, as of August 31, 2023, according to the New York Federal Reserve. Starting on September 1, interest will once again accrue on U.S. student loan balances, following a three-and-a-half-year, federally mandated break from monthly payments and interest. Student loan recipients are expected to begin making payments again starting in October 2023.

Education planning can be a crucial part of your overall financial plan, and 529 plans can be a great option to allow funds to grow tax-free over time, without paying income taxes on withdrawals when the money is used for qualified education-related expenses in the future. The earlier you start contributing to a 529 plan, the more compound interest you could earn over time to support education-related goals for your children or your grandchildren.

Understanding 529 Plans

Named after section 529 of the Internal Revenue Service Code, a 529 plan is a tax-deferred, tax-advantaged education savings vehicle that is sponsored by a state, state agency, or educational institution. All 50 states and the District of Columbia sponsor at least one type of 529 plan. Designed to allow tax-free withdrawals for qualified educational expenses, 529 plans can be a smart option for many families. Unlike other savings accounts, a 529 plan gives the account owner greater control and flexibility while allowing for higher contribution limits. Any family member can open a 529 account and anyone can contribute to it, whether they are the student’s parents, grandparents, aunts or uncles.

There are two main types of 529 accounts: education savings plans and prepaid tuition plans. Education savings plans fluctuate with the stock market with investment options like mutual funds, money market funds, and age-based portfolios. Prepaid tuition plans lock in current tuition rates and are designed for families who may be hesitant about linking college funds to the stock market.

It's important to note that funds in a 529 account are available for more than just K-12 or college tuition. Allowable withdrawals are permitted for education-related expenses, including room and board, books, computers, and study abroad programs. Funds are also transferable between siblings at no penalty, so if one child needs more money for college and another child needs less, you have the flexibility to make adjustments in the future. Additionally, starting in 2024, excess funds in 529 accounts can be transferred directly into a Roth IRA to jumpstart their beneficiaries retirement savings.

Individuals selecting a 529 savings account should plan accordingly, based on the level of funding they ultimately want to provide. For instance, the difference in funds needed to attend a public university vs. a private university is significant. Another consideration is if funding is to be used on a portion of undergraduate tuition or to cover all expenses from freshman year all the way through a doctorate degree.

Important Considerations

Potential Tax Consequences

It’s critical to remember that there are potential tax consequences for not using 529 plan funding toward tuition and qualified education-related expenses. You don’t want to “overfund” a 529 account and to pay tax penalties down the road. For some families, a combination of a 529 college savings plan plus another investment savings account might be the most strategic option to avoid overfunding a 529 account and incurring penalties in the future.

Contribution Limits

The Internal Revenue Service does not impose federal contribution limits on 529 plans – plus contribution limits vary by state. A five-year gift tax average option that allows investors to contribute a lump sum equal to five times the annual gift tax exclusion applies to 529 accounts. In 2023, the annual gift tax exclusion increased to $17,000 per individual or $34,000 per married couple. Investors can contribute up to five times that annual figure as a “superfunding” lump sum, contributing up to $85,000 as an individual or $170,000 as a married couple under current gift tax laws.

Variability From State to State

Investors are free to choose any 529 plan across the United States, regardless of whether they live in the state offering the plan. Explore various plans offered by your state and others, since the costs and benefits can vary widely. A 529 plan in Utah or Nevada, for example, may be a better fit for you and your family, even if you live in Georgia. A professional advisor can provide guidance about the pros and cons of various state-based 529 plans.

Education Inflation

Bankrate recently reported that the average annual rate of college tuition inflation is 8%. According to a report from the Georgetown University Center on Education and the Workforce, the average price of tuition, fees, and room and board for an undergraduate degree increased 169% between 1980 and 2020. Anticipating education inflation is key to the success of any 529 plan, since tuition, fees, and a host of education expenses are far from static, fixed costs. Include inflation projections in your 529 planning to make sure you are setting aside enough funding to achieve future education goals.

Work with your financial planner to determine how college saving fits into your overall financial plan, set goals, and monitor changing laws governing education savings accounts. In addition, your advisor can adjust tuition for cost inflation and provide guidance regarding strategic 529 plan funding.  

Want to learn more about strategic ways to save for education expenses? Please reach out to us to get started.